Economical Insurance 2015 Annual Report imag… · 2015 ANNUAL REPORT HEAD OFFICE 111 Westmount Road South P.O. Box 2000, Waterloo, ON N2J 4S4 T 519 570 8500 F 519 570 8389 economicalinsurance.com

2 0 1 5 A N N U A L R E P O R T

HEAD OFFICE111 Westmount Road SouthP.O. Box 2000, Waterloo, ON N2J 4S4T 519 570 8500 F 519 570 8389

e co n o m ic a l insu r a n ce .co m

customer satisfaction BASED ON 81,000+ CLAIMS

Rounded to the nearest per cent.

WHO WE ARE Since 1871, Economical Insurance has been protecting Canadians with innovative home, automobile and commercial insurance products and a market-leading claims service designed with our policyholders in mind.

Today, Economical is one of Canada’s leading property and casualty (P&C) insurance companies.

Proudly headquartered in Waterloo, Ontario, we serve more than one million policyholders across the country through a national independent broker force that demands fresh approaches to meet evolving consumer and business needs.

Behind the scenes and in the field, it is our employees and valued broker partners that make the difference. They are the reason we have come this far, and the reason we will go much further. We focus on our customers first, we bring our best, and we are stronger together.

WHERE WE ARE GOING Economical strives to be a company that thinks differently about insurance. By doing this, we hope people will feel differently about insurance. Our goal is to provide a simpler, more transparent process — one that can be trusted and relied on from beginning to end. We want to be the insurance partner Canadians choose to protect what they value most.

Investments in innovation, customer service, and operations underpin the future of Economical. Our company is poised to grow, invest, and deliver value to its broker partners and customers.

After filing a claim, 92% of Economical policyholders indicated that they are satisfied or very satisfied with the quality of their service experience, based on a response rate of 24%*. We are proud to live up to our promise by delivering superior claims adjudication and service when our customers need us most. * P ercentage based on 81,704 Economical claimant survey responses measuring customer satisfaction

with claims services from January 2007 - December 2015.

On May 1, 2015, A.M. Best affirmed a financial strength rating of A- (Excellent) and an issuer credit rating of A- for Economical Mutual Insurance Company and Waterloo Insurance Company, a wholly owned subsidiary. The outlook for all ratings is stable. This recognizes Economical’s excellent financial strength and strong operating performance. It also reinforces confidence in our customers and broker partners that we will be there when they need us most. A.M. Best continues to acknowledge Economical’s focused marketing and branding strategies, disciplined underwriting philosophy and pricing segmentation, solid risk-adjusted capitalization, historically positive operating performance, diversified product offerings, and established Canadian market presence.

The Economical brand includes the following property and casualty insurance companies: Economical Mutual Insurance Company, Perth Insurance Company, Waterloo Insurance Company, The Missisquoi Insurance Company.

©2016 Economical Insurance. All rights reserved. All Economical intellectual property, including but not limited to Economical® and related trademarks, names and logos are the property of Economical Mutual Insurance Company and/or its subsidiaries and/or affiliates and are registered and/or used in Canada. All other intellectual property is the property of their respective owners.

2015 PERFORMANCE AT A GLANCE

GROSS WRITTEN PREMIUMS (GWP) ($ billions)

In 2015, we achieved a significant milestone, delivering more than $2 billion in GWP, the highest level in our company’s history and $45.4 million more than the prior year.

102.1% 100.1% 98.1% 96.5% 97.4%

2011 2012* 2013 2014 2015

* 2012 restated for Pension Adjustment impact of 0.1 percentage points.

COMBINED RATIO (COR)

Our COR for 2015 was 97.4%, a significant improvement of 4.7 percentage points over 2014. The improved results were due to underwriting and pricing actions taken to improve profitability, relatively benign weather conditions, improved results in commercial property and liability and a return to more normal levels of favourable claims development.

TOTAL EQUITY ($ billions)

Our book value increased by $97.9 million, or 5.8% in 2015 to a record $1.78 billion.

1.78 1.68 1.57 1.46

1.30

2011 2012 2013 2014 2015

2.01 1.96

1.92

1.82

1.72

2011 2012 2013 2014 2015

34.5% 34.8%33.3%

32.9% 32.7%

2011 2012* 2013 2014 2015

* 2012 restated for Pension Adjustment impact of 0.1 percentage points.

295.1% 295.2% 295.4% 285.2%

269.4%

2011 2012 2013 2014 2015

NET INCOME ($ millions)

Net income for 2015 more than doubled from $84.2 million to a record $176.0 million, driven by strong underwriting performance and increased investment income.

176.0

151.0

91.0 87.7 84.2

2011 2012* 2013 2014 2015

* 2012 restated for Pension Adjustment impact of $1.7 million.

EXPENSE RATIO

Our expense ratio in 2015 of 33.3% includes 2.1 percentage points from our ongoing infrastructure and operational investments. We believe these investments will drive profitable growth and further improve our operating efficiency in the longer term.

MINIMUM CAPITAL TEST (MCT)

Our MCT ratio of 285.2% continues to be strong and is significantly in excess of both internal capital management and external regulatory requirements as of December 31, 2015.

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A MESSAGE FROM JOHN H. BOWEY, CHAIRMAN OF THE BOARD

Economical has entered one of the most exciting eras in our corporate history. Between demutualization and a new multichannel distribution model, we’re positioning ourselves to compete aggressively at one of the most dynamic times in our industry.

The past year has been pivotal for Economical. Our industry is not the same as it was 10 years ago — or even one year ago. Consolidation is accelerating among our top competitors who are growing in scale and in reach, swallowing up both market share and market players.

UNLOCKING OUR FULL POTENTIAL THROUGH DEMUTUALIZATION

Demutualization enables us to pursue our aspirations. As a share company, we will have access to capital that we can’t

access now: funds for expansion, for acquisition, and to expedite our recovery if we are ever impaired by an extreme disaster event. It will level the playing field, giving us the same market-driven advantages as our major competitors, most of which are public companies or backed by large multi-nationals.

At a special meeting in December, eligible mutual policyholders voted overwhelmingly in favour of commencing negotiations with non-mutual policyholders on the allocation of demutualization benefits through court-appointed policyholder committees. Their support reinforces that we are on the right path to unlocking the full potential of our company as a leader in our industry.

2015: AN IMPRESSIVE YEAR

Economical is a strong and thriving business, as evidenced by our impressive results in 2015. Even as we implemented changes focused on improving future profitability, we achieved record-level top-line revenues, recorded the highest net income in our history and our book value has never been higher. With a significant reduction in catastrophe losses in 2015, key performance indicators are pointing in the right direction: revenues are up, our profitability is strong, and our investments in our infrastructure and capabilities are showing great progress.

To achieve our vision to be one of Canada’s top P&C insurers recognized for our business innovation and how well we take care of our customers, we have an ambitious strategy focused on sustaining profitable growth and operating effectively. Given the pace of change in our industry, our strategy connects today with tomorrow so we are in control of our future with actions that will make Economical the insurance partner Canadians chose to protect what they value most.

BOLD MOVES TO POWER GROWTH

Today’s marketplace is being disrupted by technology and shifting consumer expectations. Whether Canadians choose to buy their insurance through a broker or opt for a direct channel, they expect more from their insurance provider. Convenience, innovation, and stability are all important considerations. To serve a diverse market and more boldly compete with market leaders, Economical is launching a separately-branded direct-to-consumer business in 2016 to power profitable future growth.

CHANGES AT THE HELM It is with mixed emotions we also announced two significant leadership changes in the last year.

After the historic vote by our mutual policyholders in December, Gerry Hooper decided to step down as board chair effective January 4, 2016, triggering our board chair succession plan. We have benefitted from Gerry’s business acumen, his wisdom, and his leadership during his 11-year tenure as board chair. He has positioned us for success on our path to becoming a public company. We are very fortunate he will continue to serve on the board until his current term ends in 2018.

We also announced in February 2016 that Karen Gavan will be retiring from the company at the end of the year when her contract expires. Karen has been a remarkable leader over the past five years, during which our total equity grew by more than $500 million to a record level of nearly $1.8 billion today. She has been instrumental in evolving our business strategy and ensuring we have the best people delivering on our vision.

Thanks to Karen’s leadership, we are moving forward with our transition to becoming a high-performing public company from a position of strength — financially, operationally, and culturally. Economical has a very clear vision and purpose. Our successful business transformation made the company’s

operations more efficient and agile, while reducing expenses. We have an expanding and loyal policyholder base. We have deep relationships with our broker partners. Karen’s executive team has the depth of experience and a proven track record of success to drive change and build a more competitive, growth-oriented company, with enormous potential to be a leader in our industry.

We all owe Karen and Gerry our heartfelt thanks for the enormous contribution they have both made to the company.

On behalf of the board of directors, I want to acknowledge the unwavering trust and confidence our broker partners and customers continue to show in Economical. As we position ourselves to compete in new ways, the sustained growth of our broker business is vital to our future success. I also want to thank our leaders and employees for their drive and commitment to achieve our vision — you are the strength of the company and the bedrock of our success.

Sincerely,

JOHN H. BOWEY Board chair

“To achieve our vision to be one of Canada’s top P&C insurers...we have an ambitious strategy focused on sustaining profitable growth and operating effectively.”

2015 ANNUAL REPORT 5

6

A MESSAGE FROM KAREN GAVAN, PRESIDENT AND CEO

An exciting new chapter in Economical’s history has begun. This past year was particularly significant as we achieved record-setting financial performance and set the stage for both a ground-breaking demutualization and expansion into the huge potential of the direct market.

These achievements clearly demonstrate that our vision — to be one of Canada’s top P&C insurers, recognized for our business innovation and how well we take care of our customers — is not only within our sights, but within our reach. Our journey toward becoming a strong, Canadian-owned, independent public company is now well underway.

RECORD TOP-LINE REVENUE AND NET INCOME IN 2015

We generated strong profitability in 2015, delivering the highest levels of both gross written premiums and net income for any year in our company's history. We attained a significant milestone in 2015 with gross written premiums for the year exceeding $2 billion for the first time in our history, despite taking corrective underwriting and pricing actions and feeling the impact of mandated Ontario auto rate decreases. Our net income for the year more than doubled from $84.2 million in 2014 to a record $176.0 million, driven by strong underwriting performance and increased investment income. Our combined

ratio for 2015 was 97.4%, a significant improvement of 4.7 percentage points over 2014. Our total equity is at the highest level in our history at $1.78 billion.

These remarkable results were achieved despite strong headwinds from the broader economy that continue to put pressure on investment returns and asset values. Segments of our economy are very weak. With flat growth as the expected norm for a prolonged period, we are relentlessly focused on pricing and underwriting sophistication, claims management efficiency, and placing innovation at the heart of all we bring to the market.

In 2015, the independent rating agency A.M. Best once again reaffirmed our financial strength and performance with an “A- (Excellent)" rating for Economical and Economical Select. This bolsters the confidence of our broker partners to recommend Economical to their customers.

BREAKING NEW GROUND THROUGH DEMUTUALIZATION

We also achieved significant milestones in our pursuit of demutualization with the emergence of both draft and final demutualization regulations, and the overwhelming endorsement of our mutual policyholders at our first vote held in December. As a publicly traded company, we will have access to new sources of capital to make strategic investments that will drive growth and increase our market share.

As the demutualization process unfolds, we are not standing idle. We’re actively preparing for life after demutualization to ensure Economical is successful as a strong and independent public company. Our financial results to this point, as a mutual company, have been excellent. Our investments in innovation are showing great progress. Through our enhanced sophistication in predictive analytics and more effective pricing and segmentation of our business, we put the customer at the centre of all we do, offering best-in-class service and market-leading products.

STRENGTHENING OUR COMPETITIVE POSITION THROUGH MULTI-CHANNEL DISTRIBUTION

Technology will disrupt the insurance industry and it empowers consumer choice and behaviour. There is a clear divide between consumers who trust and value the advice of a broker and those who are more self-sufficient, preferring to purchase insurance through direct channels.

To win in this shifting and very competitive marketplace, we made the strategic decision to pursue multi-channel distribution. Our separately-branded direct channel will operate independently from our broker channel and allow us to reach a segment of consumers we currently do not service. Our focus on putting the customer first, leveraging advanced analytics

2015 ANNUAL REPORT

in pricing sophistication and product delivery will create competitive advantage.

We are making significant investments in our operating effectiveness with a new, flexible, and scalable policy administration system. It will enable us to deliver excellent service at lower operating costs, resulting in increased customer satisfaction. For our broker partners, it will introduce a level of ease, simplicity, efficiency and speed to market that will transform how brokers do business with us. Once implemented, our new policy administration system will also enable us to effectively integrate future acquisitions.

OUR BROKER CHANNEL IS VITAL TO OUR FUTURE SUCCESS

I want to thank our brokers and partners for their commitment and support. We are poised for great growth in the broker channel. Our long-lasting, strategic relationships with brokers thrive on mutual respect and support. Every day we value the advice of our brokers as we continuously improve the efficiency of our service delivery and our market agility. In the coming year, as we activate our multi-channel platform, we will work to ensure that our broker partners understand changing market dynamics and are well-positioned to meet them. We are committed to growing our broker business and will continue to help our partners win business, earn customer trust and enhance customer retention.

OUR CULTURE AND OUR PEOPLE: LIVING OUR VALUES EVERY DAY

The tremendous success we achieved in 2015 would not have been possible without the commitment and determination of our people. Our team of 2,200 dedicated employees is advancing the organization by living our values every day to

achieve our mission. Every day our employees are stronger together, they bring their best, and always put the customer first.

It’s paying off. More than 92% of our policyholders indicate that after filing a claim they are satisfied or very satisfied with the quality of their experience. We are proud to be a valued and reliable partner when our customers need us most.

We continue to breathe new life into our company culture as a powerful force of competitive advantage across all facets of our business.

A TIME OF TRANSITION

It is bittersweet that this will be my last letter to you. At the end of 2016 I will be retiring as president, CEO and director of the company. We can all be proud of what Economical has accomplished over the past five years. It has been an unprecedented period of change and today, the company has an incredibly strong foundation on which to build a true leader in the Canadian P&C industry.

We achieved great things in 2015. In my last year at Economical, I am excited about tapping into the incredible potential within the company — our employees, our culture, the way we relate to one another as we work and contribute together. Our future holds tremendous promise. We are ready to become a public company, compete with market leaders as a successful multichannel distributor, and be the insurance partner Canadians can trust to protect what they value most.

Sincerely,

KAREN GAVAN President and chief executive officer

“We generated strong profitability in 2015, delivering the highest levels of both gross written premiums and net income for any year in our company's history...with GWP for the year exceeding $2 billion for the first time...”


MANAGEMENT’S DISCUSSION AND ANALYSIS

TABLE OF CONTENTS

Introduction 10

Section 1 – Corporate Overview 11

Section 2 – Financial Performance 12

Section 3 – Results by Line of Business 16

Section 4 – Business Developments and Operating Environment 19

Section 5 – Canadian P&C Industry Outlook 20

Section 6 – Financial Condition 22

Section 7 – Liquidity and Capital Resources 27

Section 8 – Commitments and Contingencies 29

Section 9 – Related Party Transactions 30

Section 10 – Accounting and Internal Controls 31

Section 11 – Financial Instruments 34

Section 12 – Risk Management 35

Section 13 – Non-GAAP Financial Measures 44

Section 14 – Definitions 45



INTRODUCTION

April 4, 2016

The following Management’s Discussion and Analysis (“MD&A”) is the responsibility of management and has been approved by the Board of Directors. This MD&A is intended to enable the reader to assess our financial condition and results of operations as at and for the year ended December 31, 2015, as compared to our year ended December 31, 2014. The information in this discussion should be read in conjunction with our audited consolidated financial statements and accompanying notes for the year ended December 31, 2015. Unless otherwise noted in this MD&A, all information is prepared as at April 4, 2016.

As used in this discussion, references to “Economical”, “the Company”, “we”, “us”, and “our” refer to Economical Mutual Insurance Company, and, unless the context otherwise requires or as otherwise expressly stated, its consolidated subsidiaries.

We use both generally accepted accounting principles as defined by International Financial Reporting Standards (“IFRS”), as issued by the International Accounting Standards Board (“IASB”), which have been adopted as Generally Accepted Accounting Principles (“GAAP”), and certain non-GAAP measures to assess performance. Non-GAAP measures do not have any standardized meaning prescribed by GAAP and therefore may not be comparable to similar measures presented by other companies. These measures are outlined and defined in this MD&A. See Section 13 — ‘Non-GAAP financial measures’.

This discussion includes product names, trade names, trademarks, service marks, and registered trademarks and service marks of Economical, our subsidiaries and other companies, each of which is the property of its respective owner.

All dollar amounts are in Canadian dollars unless otherwise indicated. Certain totals, subtotals and percentages may not reconcile due to rounding. A change column has been provided showing the variation between the current year and the prior year for certain financial analyses.

This document contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from these forward-looking statements as a result of various factors, including those discussed later in the document. Please read the “Cautionary note regarding forward-looking statements” included in this MD&A.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain of the statements made in this MD&A, including, but not limited to, statements in Section 5 — ‘Canadian P&C industry outlook’ and statements regarding our current and future plans, expectations and intentions, results, levels of activity, performance, goals or achievements, or any other future events or developments constitute forward-looking statements. When used in this document, the words “may”, “will”, “would”, “should”, “could”, “expects”, “plans”, “intends”, “trends”, “indications”, “anticipates”, “believes”, “estimates”, “predicts”, “likely”, “looking to” or “potential” or the negative or other variations of these words or other similar or comparable words or phrases, are intended to identify forward-looking statements.

Forward-looking statements are based on estimates and assumptions made by management based on management’s experience and perception of historical trends, current conditions and expected future developments, as well as other factors that management believes are appropriate in the circumstances. Many factors could cause Economical’s actual results, performance or achievements or future events or developments to differ materially from those expressed or implied by the forward-looking statements, including, without limitation, the following factors: the competitive market environment; Economical’s ability to appropriately price its products to produce an acceptable return; its ability to accurately assess the risks associated with the insurance policies that it writes; its ability to pay claims in accordance with our insurance policies; management’s ability to accurately predict future claims frequency or severity including the frequency and severity of weather-related events; the occurrence of unpredictable catastrophic events; Economical’s ability to obtain reinsurance coverage to alleviate risk; Economical’s ability to successfully manage credit risk from its counterparties; unfavourable capital market developments or other factors which may affect our investments; general economic, financial and political conditions; foreign currency fluctuations; Economical’s ability to implement its strategy or operate its business as management currently expects; Economical’s dependence on key employees; Economical’s reliance on independent brokers to sell its products; Economical’s ability to uphold its independent third-party ratings; Economical’s ability to meet payment obligations as they become due; the risk of financial loss from an inadequate enterprise risk management framework; Economical’s ability to manage the appropriate collection and storage of information; Economical’s reliance on information technology and telecommunications systems; changes in government regulations, supervisory expectations or requirements, including risk-based capital guidelines; litigation and regulatory actions; success and timing of the demutualization process; the outcome of a demutualization transaction; periodic negative publicity regarding the insurance industry or Economical; and Economical’s ability to respond to events impacting its ability to conduct business as normal.

All of the forward-looking statements included in this MD&A are qualified by these cautionary statements and those made in Section 12 — ‘Risk management’. These factors are not intended to represent a complete list of the factors that could impact Economical, however, these factors should be considered carefully, and readers should not place undue reliance on forward-looking statements we make. We are under no obligation and have no intention to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

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SECTION 1 — CORPORATE OVERVIEW

ABOUT ECONOMICAL INSURANCE

Founded in 1871, Economical Insurance is one of Canada’s leading property and casualty (“P&C”) insurers. A Canadian mutual insurance company, we provide a wide range of personal and commercial insurance products to customers in most provinces and territories across Canada. We compete against Canadian and foreign-owned stock-based companies, branches, cooperatives and mutual companies. Our head office is located in Waterloo, Ontario, with branches and service offices across the country providing service to policyholders and brokers. We partner with independent insurance brokers who work with customers to assess their insurance needs and choose the right products and coverage. We are committed to providing our broker partners and policyholders with the products and services that today’s market demands.

Our financial stability is demonstrated by assets over $5.3 billion and total equity of approximately $1.8 billion as at December 31, 2015, reflecting the combined strength of our member companies.

This year was a pivotal time in our history. We refreshed our mission, vision and values. We continued our journey to demutualization. In recognition of the ongoing growth in the direct distribution channel in the P&C industry, we have announced plans to implement a multi-channel distribution strategy. We will be expanding our distribution capabilities by launching a separately-branded direct channel offering in 2016, allowing us to serve this distinct market segment.

CORPORATE STRATEGY

Our strategy plots the course to achieve our vision — to be one of Canada’s top P&C insurers, recognized for our business innovation and how well we take care of our customers. It builds on our 145-year heritage, and is powered by two imperatives: growing our business profitability and operating effectively. Across Economical, we are focused on four core strategic thrusts:

Serving customers according to their needs and preferences

We are building on our strong relationships with our broker partners by arming them with new tools and training — all to enhance their competitiveness in a changing marketplace, and expand our market share in the broker distribution channel. To reach customers who prefer to purchase and service insurance themselves, we have committed significant resources to build a new, separately-branded direct channel. Both channels are supported by ongoing investments in new technologies and advanced analytics aimed at leveraging sophisticated insights in marketing, pricing, product design and business mix optimization.

Achieving scale and diversification inorganically

We are currently pursuing demutualization under a framework established by the federal government in 2015. The culmination of that process is a planned initial public offering (“IPO”), which will open access to capital markets and significantly enhance our ability to acquire other companies. In anticipation of our IPO, we have built sophisticated risk management, corporate governance, corporate development, investment management and reporting capabilities. In the meantime, we continue to seek small and medium-sized acquisition opportunities and are actively expanding our strategic partnerships both with brokers and in other areas of our business.

Creating industry-leading productivity, agility and efficiency

Flexible and scalable processes and systems are essential to respond to rapidly changing industry conditions. We are building on the efficiencies gained from our recently completed business transformation program (“BTP”) to drive ongoing improvements in our operating performance and cost competitiveness. During 2015 we upgraded our information technology infrastructure, and are in the process of replacing our legacy policy administration system with a leading technology platform, which will significantly improve our ability to deliver products and services to market quickly and efficiently.

Enabling a thriving values-based culture that delivers on our brand

We know there is a strong relationship between a highly engaged workforce and company performance; engaged employees produce superior quality, deliver better financial results, create better customer experiences, and drive continuous improvement and innovation. We are focused on inspiring an engaging environment that enables our people to maximize their individual and collective contribution to long-term value creation. At the same time, we are strengthening our culture of service excellence to deliver best-inclass service to our customers, our brokers, and within our organization.

| 2015 ANNUAL REPORT 11


SECTION 2 — FINANCIAL PERFORMANCE

FINANCIAL HIGHLIGHTS FOR THE YEAR:

• Reported record levels of gross written premiums, net income and total equity for the year

• Increased gross written premiums by 2.3% compared to 2014 to a milestone level of $2.0 billion

• Recorded a combined ratio of 97.4%

• Generated net income of $176.0 million

• Increased total equity by $97.9 million since December 31, 2014 to $1.78 billion

RESULTS FROM OPERATIONS

Figure 1 shows the results from operations for the year ended December 31.

Figure 1 (in millions of dollars, except as otherwise noted) 2015 2014 $ Change % Change

Policies in force1 (thousands) 1,201.2 1,167.9 33.3 2.9%

Gross written premiums1 2,008.4 1,963.0 45.4 2.3%

Net premiums written1 1,935.4 1,877.8 57.6 3.1%

Net premiums earned 1,905.7 1,845.3 60.4 3.3%

Net claims and adjustment expenses, undiscounted 1,221.5 1,281.2 (59.7) (4.7%)

Other underwriting expenses2 635.4 602.5 32.9 5.5%

Underwriting income (loss)1 48.8 (38.4) 87.2 (227.1%)

Impact of discounting (1.5) (16.0) 14.5 (90.6%)

Underwriting income (loss) including the impact of discounting 47.3 (54.4) 101.7 (186.9%)

Investment income 179.5 164.2 15.3 9.3%

Other income (expense) 2.9 (3.6) 6.5 (180.6%)

Restructuring expenses - (1.3) 1.3 (100.0%)

Income before income taxes 229.7 104.9 124.8 119.0%

Income tax expense 53.7 20.7 33.0 159.4%

Net income 176.0 84.2 91.8 109.0%

Claims ratio1 64.1% 69.4% (5.3) pts

Expense ratio1,2 33.3% 32.7% 0.6 pts

Combined ratio1,2 97.4% 102.1% (4.7) pts

Return on equity1 10.5% 5.4% 5.1 pts

Minimum capital test (“MCT”)1 285.2% 295.4% (10.2) pts

1 Refer to Section 13 — ‘Non-GAAP financial measures’. These non-GAAP measures are considered key performance indicators, and are measures that we monitor regularly. 2 Other underwriting expenses, the expense ratio, and the combined ratio are presented in the MD&A net of other underwriting revenues.

GROSS WRITTEN PREMIUMS AND POLICIES IN FORCE

We continue to generate growth in both gross written premiums (“GWP”) and policies in force (“PIF”). Growth occurred in personal lines and was driven primarily by increased auto policy volumes in Ontario, British Columbia and Alberta as well as growth in personal property driven by targeted rate increases and increased policy volumes in Ontario and Alberta. In commercial lines, GWP levels were impacted by ongoing underwriting and pricing actions which resulted in decreased policy volumes, more than offsetting targeted rate increases in commercial property. Commercial auto GWP was impacted by declines in PIF due to the non-renewal of certain non-core fronting arrangements in the fourth quarter of 2014. Our focus remains one of profitable growth and, as such, we focus on discipline in our pricing and underwriting approach to ensure that underwriting performance is not sacrificed to achieve top-line premium growth. Further details by line of business are provided in Section 3 — ‘Results by line of business’.

12 | 2015 ANNUAL REPORT


NET PREMIUMS WRITTEN AND NET PREMIUMS EARNED

Net premiums written and net premiums earned grew relatively consistent with the GWP growth. Net premiums written and net premiums earned outpaced the GWP growth primarily as a result of reduced reinsurance costs.

NET CLAIMS AND ADJUSTMENT EXPENSES

Figure 2 summarizes the composition of the claims ratio for the year ended December 31, illustrating the impact of accident year claims incurred, catastrophe losses, and prior year favourable claims development.

Figure 2 (in millions of dollars, except as otherwise noted)

2015 2014 Change

$ Ratio $ Ratio $ Ratio

Core accident year claims 1,272.8 66.8% 1,238.6 67.1% 34.2 (0.3) pts

Catastrophe losses 21.8 1.1% 45.5 2.5% (23.7) (1.4) pts

Prior year favourable claims development (73.1) (3.8%) (2.9) (0.2%) (70.2) (3.6) pts

Total 1,221.5 64.1% 1,281.2 69.4% (59.7) (5.3) pts

The core accident year claims ratio, which excludes catastrophe losses and prior year favourable claims development, was relatively unchanged as compared to the prior year.

Current year net weather-related catastrophe losses decreased from the prior year reflecting relatively benign weather conditions. In 2015, we incurred losses as a result of five catastrophe events, including an Ontario deep freeze water storm in February, a British Columbia lower mainland wind and water storm in August, and losses associated with three separate wind and hail storms in Alberta. In 2014, we incurred losses as a result of nine catastrophe events, including a deep freeze in January mainly in Ontario and a hail, wind and rain storm in central Alberta in August.

Prior year favourable claims development significantly improved in 2015 as compared to the prior year. In Ontario, Budget Bill 15 — ‘Fighting Fraud and Reducing Automobile Insurance Rates Act, 2014’ (“Bill 15”) came into effect. Among other measures, it reduced the level of mandated pre-judgment interest on certain auto liability claims. Furthermore, legislated budget reforms pertaining to the statutory deductible applicable for non-pecuniary damages for Auto Bodily Injury Claims in Ontario took effect August 1, 2015. The changes included an increase in the statutory deductible, an increase to the threshold above which the deductible does not apply, and the inclusion of the deductible in calculating plaintiff costs. These reforms had a favourable impact on open claims with a date of loss of 2014 and prior. In addition, there was improved claims development in commercial property and liability compared to the prior year. This was partially offset by a strengthening of reserves for Ontario auto accident benefit costs.

Refer to Figure 16, which shows the level of prior year favourable claims development over the past ten calendar years, and demonstrates our continued prudent reserving practices.

OTHER UNDERWRITING EXPENSES

Figure 3 shows the key components of our reported expense ratio for the year ended December 31.


2015 2014 Change


Net commissions 363.7 19.1% 356.9 19.3% 6.8 (0.2) pts

Operating expenses 205.0 10.7% 180.6 9.9% 24.4 0.8 pts

Premium taxes 66.7 3.5% 65.0 3.5% 1.7 0.0 pts

Total 635.4 33.3% 602.5 32.7% 32.9 0.6 pts

The impact of net commissions on our expense ratio decreased slightly. We continue to evaluate commission structures to better align commissions paid with the underlying performance of the book of business.

The operating expenses ratio increased in 2015. The completion of the BTP in the fourth quarter of 2014 reduced the run rate of ongoing operating expenses, but this was more than offset by continued infrastructure and operational investments, including costs associated with the replacement of our policy administration system and costs to support our multi-channel distribution platform. These strategic initiatives increased the operating expense ratio by 2.1 percentage points during 2015 compared to 0.4 percentage points in 2014. The impact of the BTP costs on the 2014 operating expenses ratio was 0.4 percentage points. Excluding the impact of these strategic initiatives, the operating expenses ratio decreased 0.5 percentage points in 2015.

We expect our strategic infrastructure and operational investments will continue to increase operating expenses during the implementation phases. In the longer term, these investments are expected to improve productivity and our ability to deliver products and services to the market in a timely, competitive and efficient manner, and will support the expansion of our distribution capabilities and our core broker channel.



UNDERWRITING RESULTS

Figure 4 summarizes the composition of the undiscounted and discounted combined ratio for the year ended December 31.


2015 2014 Change


Claims ratio 1,221.5 64.1% 1,281.2 69.4% (59.7) (5.3) pts

Expense ratio 635.4 33.3% 602.5 32.7% 32.9 0.6 pts

Combined ratio, undiscounted 1,856.9 97.4% 1,883.7 102.1% (26.8) (4.7) pts

Impact of discounting 1.5 0.1% 16.0 0.9% (14.5) (0.8) pts

Combined ratio, discounted 1,858.4 97.5% 1,899.7 103.0% (41.3) (5.5) pts

Our underwriting results significantly improved over the prior year due to our underwriting and pricing actions taken to improve profitability, relatively benign weather conditions, the Ontario auto reforms enacted in 2015, and improved results in commercial property and liability compared to 2014. The impact of the infrastructure and operational investments on the combined ratio was 2.1% (2014: 1.4%). Refer to Section 3 — ‘Results by line of business’ for additional details.

The discounting expense decreased as compared to the prior year as the decline in yields in 2015 was lower than the decline in yields in 2014. Also, the discounting expense was partially offset by a reduction in the interest rate margin considered within the claim liabilities to reflect the drop in bond yields to historically low levels.

INVESTMENT INCOME

Figure 5 shows the composition of investment income recorded in the consolidated statement of comprehensive income for the year ended December 31.


Interest income 67.7 76.7 (9.0) (11.7%)

Dividend income 37.9 29.5 8.4 28.5%

Total interest and dividend income 105.6 106.2 (0.6) (0.6%)

Realized gains on Available for Sale (“AFS”) portfolio 65.9 34.8 31.1 89.4%

Realized gains on Fair Value Through Profit or Loss (“FVTPL”) bonds 36.7 13.3 23.4 175.9%

Unrealized (losses) gains on FVTPL bonds (9.0) 14.6 (23.6) (161.6%)

Net impairment losses on AFS portfolio (19.7) (4.7) (15.0) 319.1%

Total recognized gains on investments 73.9 58.0 15.9 27.4%

Total investment income 179.5 164.2 15.3 9.3%

During the year, we continued to focus on the optimization of returns in our investment portfolio. Interest income decreased as compared to the prior year due to the persistently low interest rate environment. The market yield of the consolidated bond portfolio declined 7 basis points year over year (2014: 41 basis points). To optimize our portfolio performance while counteracting the low interest rate environment, we have continued to increase our investments in high quality common and preferred stocks, resulting in an increase in dividend income year over year.

A subset of the bond portfolio is designated as FVTPL. Changes in the fair value of FVTPL instruments are included in recognized gains on investments in the consolidated statement of comprehensive income. The designation of the FVTPL bond portfolio aims to reduce the accounting mismatch in net income that would otherwise be generated by the fluctuations in fair values of underlying claim liabilities due to changes in interest rates. We manage the FVTPL portfolio’s quantum and duration so that the impact of changes in interest rates on claim liabilities and the FVTPL portfolio reasonably offset each other. To further optimize the performance of the portfolio, a change in strategy with the FVTPL bonds began to be implemented in the second quarter of 2015. Gradually, the FVTPL portfolio will be shifted whereby the quantum will be reduced and the average duration increased. This strategy is intended to continue to achieve the objective of reducing the accounting mismatch in net income while allowing a larger portion of the portfolio to be invested in higher yielding assets that remain of a high quality. This strategy will also more closely align us with our public company peers. As at December 31, 2015, the quantum of investments in the FVTPL portfolio represented 82.9% (2014: 99.5%) of the underlying claim liabilities. The balance of the bond portfolio, along with the short-term investments and equity portfolios, is designated as AFS. Changes in the fair value of AFS instruments are included in other comprehensive (loss) income (“OCI”) unless the instrument is disposed of or considered to be impaired in which case they are included in net income.



Realized gains on the AFS portfolio increased compared to the prior year, primarily driven by first quarter gains in Canadian common equities and bonds. The net realized and unrealized gains (losses) on the FVTPL bond portfolio were relatively consistent with the prior year. The investment impairment losses in 2015 primarily pertain to our limited common equity energy holdings. We continue to maintain a high-quality and diversified portfolio. Refer to Section 6 — ‘Financial condition’ for additional details of our investment portfolio mix.

OTHER INCOME (EXPENSE)

In 2015, other income (expense) includes investment expenses, costs incurred to prepare for our potential demutualization, and income from our investments in associates. The increase over the prior year is primarily attributable to the sale of certain assets of an investment in an associate on September 30, 2015. We own a 30% stake in the associate and the sale resulted in a gain of $5.3 million.

RESTRUCTURING EXPENSES

As the BTP was completed in 2014, there were no restructuring expenses incurred in 2015. Costs for the BTP incurred in 2014 totalled $14.3 million. Of this amount, $13.0 million was included in underwriting expenses and $1.3 million was included in restructuring expenses. The amounts above that were recorded in underwriting expenses pertained to expenses related to the BTP that did not meet the criteria for classification as restructuring expenses.

INCOME BEFORE INCOME TAXES

Income before income taxes in 2015 more than doubled as compared to the prior year due to stronger underwriting results and increased investment income.

INCOME TAX EXPENSE

The effective tax rate for 2015 was 23.5%, compared to 19.7% in 2014. The effective tax rate continues to be lower than the statutory rate of 26.7% (2014: 26.4%) due primarily to the impact of non-taxable Canadian dividend income. Since underwriting income increased substantially during 2015, the proportionate impact of non-taxable Canadian dividend income was reduced, causing the effective tax rate to increase.

CAPITAL STRENGTH

Total equity increased $97.9 million, or 5.8%, to almost $1.8 billion, the highest in our history. This is despite an other comprehensive loss of $78.1 million (net of tax) for the year ended December 31, 2015 primarily related to a reduction in unrealized investment gains due to challenging market conditions. The MCT ratio of 285.2% as at December 31, 2015 (2014: 295.4%) continues to be strong and is significantly in excess of both internal capital management and external regulatory requirements. The new MCT framework took effect January 1, 2015. The impact to our regulatory ratio was positive and the transition adjustment will phase in over the next three years.


Ontario

British Columbia

Alberta & Prairies

Atlantic

Quebec

Other


SECTION 3 — RESULTS BY LINE OF BUSINESS

Our management and directors review the results of operations based on two reportable segments, the P&C insurance segment and the broker operations segment. More than 99% of assets are included in the insurance segment.

Within the P&C insurance segment, we provide a wide range of P&C insurance products throughout Canada in two broad lines of business: personal insurance and commercial insurance. Each line is further subdivided between automobile, property, or — in the case of commercial — property and liability lines of business.

The following charts illustrate our GWP mix on this basis for the fiscal year 2015 and 2014:

2015 GWP BY LINE OF BUSINESS 2014 GWP BY LINE OF BUSINESS

25% 43%

13%

19%

26% 41%

14%

19%

Personal auto

Personal property

Commercial auto

Commercial property & liability

2015 GWP BY REGION 2014 GWP BY REGION

1% 6%

7%

14% 57%

15%

1%

57%

6% 7%

14%

15%

Our business mix remained relatively stable in 2015 with a slight shift from commercial lines to personal auto. We increased total GWP by $45.4 million, or 2.3% in 2015. The growth in GWP in 2015 is attributed to our personal lines which grew 5.5%, while our commercial lines decreased by 2.5% as a result of our underwriting and pricing actions designed to improve the profitability of commercial property & liability, and the non-renewal of certain non-core commercial auto fronting arrangements. The underwriting and pricing actions included the execution of new commercial P&C mid-market pricing models, which began to impact GWP in the second half of 2015. GWP growth occurred in Quebec (3.0%), Ontario (2.9%), British Columbia (2.7%), and Alberta & Prairies (2.2%). The Atlantic region GWP declined by 3.4% in 2015 due primarily to our decision to exit unprofitable business lines in Newfoundland and Labrador.


UNDERWRITING — PERSONAL LINES

Figure 6 presents selected results of operations of the personal lines of business for the year ended December 31.


Policies in force (thousands)

Automobile 619.0 586.0 33.0 5.6%

Property 407.8 396.5 11.3 2.8%

Total 1,026.8 982.5 44.3 4.5%

Gross written premiums

Automobile 858.7 813.3 45.4 5.6%

Property 390.3 370.6 19.7 5.3%

Total 1,249.0 1,183.9 65.1 5.5%

Net premiums earned

Automobile 820.3 790.4 29.9 3.8%

Property 357.7 336.9 20.8 6.2%

Total 1,178.0 1,127.3 50.7 4.5%

Underwriting income (undiscounted)1

Automobile 43.5 19.6 23.9 121.9%

Property 43.0 13.2 29.8 225.8%

Total 86.5 32.8 53.7 163.7%

1The underwriting results in Figure 6 exclude costs for certain infrastructure and operational investments.

68.4 70.1

claims

26.3 27.4

expense

PERSONAL AUTOMOBILE RATIOS

94.7 97.5

combined

2015 2014

58.7 52.7

claims

35.3 37.4

expense

96.1 88.0

combined

63.6 66.7

claims

29.1 30.4

expense

PERSONAL PROPERTY RATIOS TOTAL PERSONAL LINES RATIOS


97.192.7

combined

Personal auto GWP grew in 2015 as compared to the prior year supported by strong PIF growth in Ontario, British Columbia and Alberta. The personal auto combined ratio improved in 2015 and was positively impacted by the benefit from the Ontario budget reforms enacted in 2015, discussed in Section 2 — ‘Financial performance’. These budget reforms were designed to provide some offsetting cost reductions to respond to the mandated rate decreases implemented during 2014.

Personal property GWP increased in 2015 as compared to the prior year, supported by an increase in PIF and increased pricing sophistication resulting in targeted rate increases in Ontario and Western Canada. The personal property combined ratio improved in 2015 mainly due to rate increases and relatively benign weather conditions, resulting in a decrease in current year net weather-related catastrophe losses and reduced claims frequency.

The combined ratio for total personal lines also benefited from the decline in the expense ratio. The benefits of prior year initiatives including BTP, have allowed us to contain costs and operate more efficiently.

We believe that our continuing investments in predictive analytics, underwriting sophistication, and operational efficiency will continue to drive profitable growth in personal lines.


COMMERCIAL AUTOMOBILE RATIOS

2015 2014

COMMERCIAL PROPERTY AND LIABILITY RATIOS

TOTAL COMMERCIAL LINES RATIOS


UNDERWRITING — COMMERCIAL LINES

Figure 7 presents selected results of operations of the commercial lines of business for the year ended December 31.


Policies in force (thousands)

Automobile 50.4 52.2 (1.8) (3.4%)

Property and liability 124.0 133.2 (9.2) (6.9%)

Total 174.4 185.4 (11.0) (5.9%)

Gross written premiums

Automobile 264.8 266.4 (1.6) (0.6%)

Property and liability 494.6 512.7 (18.1) (3.5%)

Total 759.4 779.1 (19.7) (2.5%)

Net premiums earned

Automobile 258.3 250.0 8.3 3.3%

Property and liability 469.4 468.0 1.4 0.3%

Total 727.7 718.0 9.7 1.4%

Underwriting income (loss) (undiscounted)1

Automobile 18.2 11.2 7.0 62.5%

Property and liability (16.7) (82.4) 65.7 79.7%

Total 1.5 (71.2) 72.7 102.1%

1The underwriting results in Figure 7 exclude costs for certain infrastructure and operational investments.

64.2 65.7

claims

28.7 29.8

expense

92.9 95.5

combined

78.0 65.2

claims

117.6103.6

combined

38.4 39.6

expense

73.7 64.9

claims

35.0 36.2

expense

99.9 109.9

combined

Commercial auto GWP decreased in 2015 as compared to the prior year. However, excluding the impact of the non-renewal of certain non-core fronting arrangements, commercial auto GWP increased 0.8%. The decrease in PIF was more than offset by a shift from small commercial auto business towards fleet business, which commands higher average premiums. The commercial auto combined ratio improved in 2015 primarily due to the benefit from the Ontario budget reforms enacted in 2015, discussed in Section 2 — ‘Financial performance’. The underlying book of business continues to perform well.

Commercial property and liability GWP decreased in 2015 due to the decline in PIF. The decline in PIF is primarily due to lower retention rates driven by targeted rate increases in all regions aimed at improving profitability.

Commercial property and liability performance has historically been challenged. In 2015, we continued to implement our underwriting and pricing actions focused on bringing the commercial line of business back to profitability. Specifically, in 2015, we introduced our new commercial P&C mid-market pricing models. Our actions contributed to significantly improved underwriting results in 2015 in this line of business. Favourable claims development, relatively benign weather conditions, and reduced net claims severity and frequency also contributed to improved operating performance. While our underwriting and pricing actions have impacted our premiums written, and are expected to continue into the first half of 2016, we believe we are well on our way to enhancing the profitability of our commercial property portfolio.

The combined ratio for total commercial lines also benefited from the decline in the expense ratio. The benefits of prior year initiatives including BTP, have allowed us to contain costs and operate more efficiently.

Our objective is to provide competitive and sustainable pricing. We continue to focus on underwriting discipline, product enhancements, targeted rate increases, and the implementation of sophisticated pricing models to achieve rate adequacy in key lines of commercial business. We believe these initiatives will continue to improve operating performance of the commercial lines of business.



SECTION 4 — BUSINESS DEVELOPMENTS AND OPERATING ENVIRONMENT

DEMUTUALIZATION

Demutualization is the process whereby a mutual company converts into a share company. On July 1, 2015, regulations were published by the federal government’s Department of Finance designed to allow federally-regulated mutual property and casualty insurance companies to demutualize. On November 3, 2015, the Company’s Board of Directors announced its decision to proceed with demutualization within the regulatory framework. At the first special meeting on demutualization held on December 14, 2015, the Company’s eligible mutual policyholders passed a special resolution to authorize the start of negotiations of the allocation of demutualization benefits with eligible non-mutual policyholders. The Company expects the demutualization process to take more than two years to complete.

ONTARIO PERSONAL AUTO ENVIRONMENT

In 2014, the Financial Services Commission of Ontario mandated rate reductions on Ontario automobile policies in anticipation of reforms in the future that would reduce the excessive costs within the system. We are encouraged that the 2015 Ontario budget released in the second quarter contained a number of changes intended to support the earlier mandated rate reductions. Changes related to costs associated with non-pecuniary damages and plaintiff costs have brought immediate cost savings. Changes slated for implementation in June 2016 are intended to address the definition of catastrophic injury and also medical, rehabilitation and attendant care benefits. There are also some changes that impact revenues for insurers that reduce the benefit of these savings, so overall the budget measures are expected to provide marginal cost relief. We are seeing deterioration in the definition of catastrophic injury and increasing claims frequency since the 2015 budget changes were conceived. There is significant risk that costs could increase if the 2016 reforms are not implemented appropriately or that the reforms may not be sufficient in light of the changes in the market in the last 12 to 18 months. The Ontario personal automobile market is very dynamic from many perspectives — political, regulatory and consumer. We continue to actively participate in industry and government consultation and respond appropriately to ensure rate adequacy.

CLIMATE CHANGE

The impact of climate change is increasing the size and frequency of weather events across the country, creating a challenging environment for the entire P&C insurance industry. This was highlighted in 2013, when the Company, along with the P&C industry in Canada as a whole, endured the worst catastrophe loss year in its history. Although catastrophe losses were lower in 2015 than in 2014, weather events are expected to continue to create increased volatility in results, particularly in our property lines of business.

CAPITAL MARKETS

The significant decline in the price of oil and its negative impact on growth, inflation, and financial stability prompted the Bank of Canada to cut its benchmark rate twice during 2015 pressurizing bond yields and depressing interest income. While the downturn in oil prices and economic outlook concerns has weighed on Canada’s stock market, foreign equities managed to produce gains for the year, with returns further boosted by a depreciating Canadian dollar. We will continue to focus on our ongoing strategy to optimize portfolio performance.

INDUSTRY CONSOLIDATION

Merger and acquisition activity in the Canadian P&C industry continued to be active in 2015, with additional consolidation in the market expected to continue. Premium levels are becoming increasingly concentrated within the industry’s top five companies. Competitive market pressures, the low interest rate environment, the need for scale, geographic diversification, and gaining access to additional distribution channels are some of the factors driving the consolidation in the industry. We intend to participate in the consolidation, and are pursuing demutualization to give us the necessary access to public capital. We are also making infrastructure and operational investments which will help to prepare us for consolidation.

CONSUMER BEHAVIOURS AND PRODUCT CHANGE

Consumer demographics and customer behaviours continue to evolve. Digital technologies are increasing the expectations from consumers for a more personalized experience from their insurance providers. Building new distribution channels is becoming increasingly important, in order to reach this distinct market segment. The purchase of insurance through direct distribution channels continues to grow in the P&C industry, and is changing the way consumers engage and interact with insurers. To respond to changing consumer behaviours, we will be expanding our distribution strategy with the launch of a separately-branded direct channel in 2016.

Changing consumer behaviours, and climate change are also having an impact on product design. Changes in weather and technology products are changing at a faster rate than they have been in the past. Insurers are designing products to absorb or deny new and emerging risks. In particular, the increased occurrence of overland flood events in Canada in recent years, particularly in Calgary and Toronto, has increased attention on the long-term viability of overland flood insurance. The growth in the sharing economy and changing consumer demographics and customer behaviours have also impacted product offerings resulting in the introduction of insurance products in the market for cyber risk, ridesharing, drones, and the use of telematics in product pricing. Automated driver assistance systems and autonomous car technologies are also expected to have a significant impact on future product design.

We are closely monitoring changes in the market. Our investment in a new policy administration system will result in a more flexible platform, allowing us to increase our capabilities to make product changes to respond to new and emerging risks.



SECTION 5 — CANADIAN P&C INDUSTRY OUTLOOK

Set out below is an overview of our expectations for the P&C industry over the next 12 months, together with our current strategies intended to further improve our industry standing. These expectations are subject to risks and uncertainties, and our actual results could differ materially as a result of various factors, including those discussed earlier in the document. Please read the “Cautionary note regarding forward-looking statements” on page 10 of this document.

Canadian P&C insurance industry Our response

Pricing and underwriting profitability

• We expect overall industry gross written premiums to show low to mid-single digit pace of growth in both personal and commercial lines.

• Ontario auto rate reductions were mandated in early 2014 impacting underwriting profitability in 2015. While the passage of Bill 15 is a positive step and will help to reduce fraud and mitigate costs in Ontario auto, we believe that greater product reform is necessary to have a meaningful long-term impact on the average cost of auto insurance in the province. However, we are encouraged by 2015 enacted budget measures to provide offsetting cost reductions.

• While catastrophe losses were relatively low in 2015, we believe that severe weather caused by climate change will continue to affect the industry and result in higher claim costs in both personal and commercial property lines.

• We expect climate change and the shift in consumer behaviours to result in the continued need for new or enhanced product coverages.

• We continue to improve our predictive analytics, pricing sophistication and processes. We expect these investments will drive profitable growth through appropriate risk pricing and avoiding anti-selection.

• We will continue to focus on improving profitability in our commercial property and liability business through a range of measures including underwriting discipline, product enhancements, and targeted rate increases based on risk pricing.

• We are implementing product changes, and continue to employ geographic segmentation to manage our overall exposure to weather-related events.

• We plan to continue our focus on operational efficiency, while enhancing risk management and underwriting capabilities.

• We are investing in a new policy administration system to improve productivity and our ability to deliver products and services to the market in a timely, competitive and efficient manner.

Multi-channel distribution

• Consumer demographics are shifting and their behaviours continue to evolve with the rise of the always connected consumer. Consumer connectivity is creating increased demand for direct offerings of insurance products. We expect growth in this part of the market to continue to increase.

• We are expanding our distribution strategy with the launch of a separately-branded direct channel in 2016. Our multi-channel distribution strategy is expected to drive profitable future growth, by optimizing our competitive position to address changing customer and market dynamics. Our broker business will continue to be a core part of our business model and will benefit from our broker investment strategy and the new policy administration system.

Economic conditions

• Interest income is expected to continue to be constrained by the low interest rate environment.

• The weak economic environment is expected to constrain growth and to result in continued volatility in global equity markets.

• The Canadian dollar is expected to continue to track the movement in oil prices, with no meaningful rebound expected in 2016. We expect that oil based economies in Western Canada will continue to be adversely impacted by low oil prices and manufacturing-based economies mainly in Ontario and Quebec, will be favourably impacted by the drop in the Canadian dollar.

• We plan to maintain an investment strategy that focuses on long-term value creation while effectively managing interest rate risk. Our target asset class allocations are aimed at maximizing returns within acceptable risk parameters.

• To further optimize the performance of the portfolio, it will continue to be shifted towards longer term and higher yielding investments that are of high quality.

• Our $4.2 billion cash and investment portfolio continues to be largely composed of high quality, actively traded securities including: Canadian fixed income investments issued or guaranteed by domestic governments, investment-grade bonds, and Canadian and foreign equities.

• Our financial position remains strong as demonstrated by our MCT ratio of 285.2% as at December 31, 2015.



Canadian P&C insurance industry Our response

Industry consolidation

• Premium levels are becoming increasingly concentrated within the industry’s top five companies, and this trend is expected to continue.

• The industry is going through a period of active consolidation at both the carrier and broker level. Scale is becoming an increasingly important factor in achieving sustainable profitability.

• We expect the heightened pace of consolidation to continue and we will continue preparing for a potential demutualization to gain access to the necessary capital to further strengthen our market position.

• We will continue to invest in corporate development capabilities and build the efficiency of our operations to more effectively position us for potential broker and carrier acquisition and integration.

• We will continue to explore smaller scale acquisition opportunities in the near term.

• We have also enhanced our broker investment strategy to better support the broker channel, which is experiencing a similar pace of consolidation as P&C companies. This includes expanding the financial and other investments that we provide our high performing broker partners to allow them to better achieve their growth and other strategic objectives. Our financial support of the broker channel is a core component of our overall broker value proposition.

Overall

• Overall results will be impacted by the scale and frequency of weather-related events and the industry’s response thereto, as well as the impact of government action to control Ontario auto costs. In a period of continued low investment returns, we expect that the industry will continue to focus on greater underwriting profitability and active consolidation.

• We will focus on our continued investments in our leading analytics capabilities and our operating platform in order to advance our competitive position. We will also focus on expanding our distribution strategy, with the launch of the separately-branded direct channel in 2016, and on corporate development capabilities and pursuing opportunities.



SECTION 6 — FINANCIAL CONDITION

FINANCIAL HIGHLIGHTS FOR THE YEAR:

• Total assets increased by $116.3 million (2.2%) to $5.3 billion

• Gross claim liabilities decreased by $51.9 million (2.2%) to $2.3 billion

• Total equity increased by $97.9 million (5.8%), to almost $1.8 billion, demonstrating our financial strength

Figure 8 shows the significant consolidated balance sheet line items as at December 31.

Figure 8 (in millions of dollars, except as otherwise noted) 2015 2014 $ Change

Cash and cash equivalents 89.0 89.2 (0.2)

Investments 4,064.9 4,061.4 3.5

Premiums receivable 601.2 581.7 19.5

Reinsurance receivable and recoverable 81.7 100.0 (18.3)

Deferred policy acquisition expenses 207.8 202.8 5.0

Goodwill and intangible assets 131.6 61.9 69.7

Other assets 168.9 131.8 37.1

Total assets 5,345.1 5,228.8 116.3

Unearned premiums 1,022.3 995.5 26.8

Claim liabilities 2,309.3 2,361.2 (51.9)

Accounts payable and other liabilities 234.5 191.0 43.5

Total liabilities 3,566.1 3,547.7 18.4

Retained earnings 1,762.2 1,581.8 180.4

Accumulated other comprehensive income 16.8 99.3 (82.5)

Total equity 1,779.0 1,681.1 97.9

Total liabilities and equity 5,345.1 5,228.8 116.3

CASH AND INVESTMENTS

Figure 9 shows the composition of our cash and cash equivalents, and investments recorded on the consolidated balance sheet as at December 31.

Figure 9

(in millions of dollars, except as otherwise noted)

2015 2014

Carrying value Percent of

carrying value Carrying value Percent of

carrying value

Cash and cash equivalents 89.0 2.1% 89.2 2.1%

Short-term investments 27.0 0.7% 39.9 1.0%

Bonds 2,969.9 71.5% 3,074.7 74.1%

Preferred stocks 370.6 8.9% 412.1 9.9%

Common stocks 558.2 13.4% 389.2 9.4%

Pooled funds 114.2 2.8% 107.4 2.6%

4,128.9 99.4% 4,112.5 99.1%

Commercial loans 25.0 0.6% 38.1 0.9%

Total cash and investments 4,153.9 100.0% 4,150.6 100.0%

Our investment strategy seeks to generate appropriate levels of income while preserving capital. The strategy focuses on maximizing our long-term capital strength, while seeking to optimize risk-adjusted returns. We have an established investment policy and strategy that is based upon our risk appetite, the prudent person approach, regulatory guidelines, and reflects the expected settlement pattern of claim liabilities.



As part of our optimization of our investment portfolio, our proportionate share of investments in fixed income securities, including cash and cash equivalents, decreased slightly to 74.3% of the total portfolio compared with 77.2% as at December 31, 2014.

Commercial loans decreased $13.1 million compared to December 31, 2014 due in part to the conversion of a $5.5 million commercial loan in the first quarter of 2015 as partial consideration for the purchase of an interest in a company holding stakes in various brokerages. The balance of the change is due to loan repayments exceeding new loans issued during the year.

Refer to Section 11 — ‘Financial instruments’ for a discussion on the classification and measurement of our financial instruments.

INVESTMENTS

Investment sector mix

Figure 10 summarizes our investments by sector as at December 31.

Figure 10


2015 2014

Short term investments and

bonds Preferred stocks Common stocks Pooled funds Total Total

Government 62% - - - 46% 48%

Financials 30% 89% 31% 16% 34% 37%

Energy 2% 7% 17% 11% 5% 4%

Telecommunications 2% - 6% 3% 2% 1%

Industrials 3% - 11% 10% 4% 3%

Utilities - 4% 1% - 2% 1%

Consumer discretionary - - 14% 4% 2% 1%

Materials - - 3% 9% 1% 1%

Consumer staples 1% - 3% 20% 2% 1%

Information technology - - 10% 16% 2% 1%

Health care - - 4% 11% 1% 1%

Total 100% 100% 100% 100% 100% 100%

Total $2,996.9 $370.6 $558.2 $ 114.2 $4,039.9 $4,023.3

The above figure demonstrates the secure and highly liquid nature of our investment portfolio with a heavy concentration in the government sector.

Investment credit quality

Figure 11 and Figure 12 illustrate the strong credit quality of our fixed income securities and preferred stocks, respectively, as at December 31.

Credit rating* — bonds

Figure 11


2015 2014



carrying value

AAA 1,642.6 55.3% 1,982.4 64.5%

AA 468.1 15.8% 283.4 9.2%

A 620.3 20.9% 576.0 18.7%

BBB 214.5 7.2% 208.7 6.8%

BB or not rated 24.4 0.8% 24.2 0.8%

Total bonds 2,969.9 100.0% 3,074.7 100.0%

* Using the lowest of Standard & Poor’s and Dominion Bond Rating Service ratings.



Credit rating* — preferred stocks

Figure 12


2015 2014



carrying value

P1 3.7 1.0% 9.6 2.3%

P2 322.6 87.1% 334.3 81.2%

P3 or not rated 44.3 11.9% 68.2 16.5%

Total preferred stocks 370.6 100.0% 412.1 100.0%

* Using the lowest of Standard & Poor’s and Dominion Bond Rating Service ratings.

We continuously monitor the credit ratings of investments within the portfolio and take the necessary actions to ensure that a high level of quality is maintained. This resulted in 92.0% (2014: 92.4%) of our bonds being rated “A-” or better and 88.1% (2014: 83.5%) of the preferred stocks being rated “P2” or better. “A-” and “P2” represent the ratings provided by two recognized rating services for high-grade bonds and preferred stocks, respectively, where both asset and earnings protection are well-assured.

Investment portfolio region of issuer

Figure 13 summarizes the region of issuer of our investment portfolio as at December 31.

Figure 13


2015 2014



carrying value

Canada 3,537.2 87.5% 3,633.3 90.3%

US 284.9 7.1% 221.5 5.5%

Europe 71.8 1.8% 104.4 2.6%

Other 146.0 3.6% 64.1 1.6%

Total 4,039.9 100.0% 4,023.3 100.0%

Our investment portfolio is mainly concentrated in Canada. Our estimated exposure to foreign exchange is outlined in Section 12 — ‘Risk management’.

Unrealized gains on AFS securities

Figure 14 outlines the unrealized gains (losses) on AFS securities by type of security as at December 31.

Figure 14 (in millions of dollars, except as otherwise noted) 2015 2014

Bonds 16.4 28.4

Preferred stocks (63.0) 3.7

Common stocks 62.0 81.5

Pooled funds 0.3 19.7

Unrealized gains 15.7 133.3

A majority of our preferred stock portfolio is comprised of securities whose dividend income is reset every five years based on a spread over the five-year Government of Canada bond yield. The decline in the bond yield, and thus the potential for lower future dividend rates combined with an increased credit spread on the issuance of new preferred shares caused the significant shift from unrealized gains to unrealized losses on these securities in 2015. We continue to view these as high quality preferred stocks as they are issued by large well-established companies. A mix of declining oil prices, deflation concerns, geopolitical risks and slow economic growth have impacted the equity markets in 2015, resulting in a decrease in the unrealized gains on common stocks and the pooled funds.

PREMIUMS RECEIVABLE AND UNEARNED PREMIUMS

The premiums receivable balance and the unearned premiums balance increased mainly driven by the overall growth in GWP.



REINSURANCE RECEIVABLE AND RECOVERABLE

Reinsurance receivable and recoverable decreased due to the timing of losses paid and receivables collected, lower levels of catastrophe losses, and lower reinsurance costs.

GOODWILL AND INTANGIBLE ASSETS

Goodwill and intangible assets increased primarily related to the capitalization of costs associated with the replacement of our policy administration system and the expansion of our distribution capabilities.

OTHER ASSETS

Total other assets increased from December 31, 2014. Income taxes receivable increased $16.1 million as a result of instalment payments outpacing the income tax expense. In addition, in January 2015 we purchased an interest in a company with investments in various insurance brokerages.

CLAIM LIABILITIES AND ADJUSTMENT EXPENSES

Figure 15 shows the change in our net unpaid claim liabilities as at December 31.


Net unpaid claim liabilities, beginning of year 2,276.9 2,206.0

Current year claims incurred 1,294.6 1,284.1

Prior year favourable claims development (73.1) (2.9)

Claims and adjustment expenses 1,221.5 1,281.2

Impact of discounting (including PfAD) 1.5 16.1

Claims paid during the year (1,262.0) (1,226.4)

Net unpaid claim liabilities, end of year 2,237.9 2,276.9

Net unpaid claim liabilities decreased slightly since December 31, 2014. The increase in favourable claims development in 2015 outpaced the overall growth in current year claims incurred. Current year claims incurred increased due to growth in business volumes. Refer to Section 2 — ‘Financial performance’ for additional details.

Figure 16 shows the level of favourable claims development as a percentage of opening net unpaid claim liabilities and the impact on the claims ratio by fiscal year.

Figure 16 (in millions of dollars, except as otherwise noted) 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006

Net unpaid claim liabilities, beginning of the year, undiscounted 2,163.3 2,108.6 2,052.1 2,122.6 2,220.0 2,200.1 2,155.0 1,932.9 1,776.4 1,493.7

Favourable development on prior year claims, undiscounted 73.1 2.9 63.0 57.4 128.9 71.8 55.7 1.1 42.3 3.1

Favourable development on prior year closing claims, undiscounted 3.4% 0.1% 3.1% 2.7% 5.8% 3.3% 2.6% 0.1% 2.4% 0.2%

Impact on claims ratio 3.8% 0.2% 3.6% 3.4% 8.0% 4.3% 3.1% 0.1% 2.3% 0.2%

2010 — 2015 under IFRS, 2006-2009 under Canadian GAAP.

These favourable trends demonstrate our continued prudent approach to claim reserving, and further support the financial strength of the organization and its capacity to meet its future claim obligations. In all years presented, our closing claim liabilities have been conservative and exceeded subsequent actual claims development related to these reserves.

ACCOUNTS PAYABLE AND OTHER LIABILITIES

Total accounts payable and other liabilities increased primarily due to costs associated with our strategic initiatives.



TOTAL EQUITY

Figure 17 illustrates the change in our total equity over the prior year.


Retained earnings 1,762.2 1,581.8

Accumulated other comprehensive income 16.8 99.3

Total equity 1,779.0 1,681.1

Change in total equity 97.9 108.0

Retained earnings increased $180.4 million since December 31, 2014 due to strong after-tax earnings in 2015. The decrease in accumulated other comprehensive income was primarily due to the reduction in unrealized investment gains on the AFS portfolio. Overall, total equity increased 5.8%.



SECTION 7 — LIQUIDITY AND CAPITAL RESOURCES

CAPITAL MANAGEMENT

As a mutual company with limited access to external sources of capital, we have adopted a capital management policy intended to ensure sufficient capital is available to protect us and our policyholders from adverse events. As a federally-regulated P&C insurance company, our capital position, along with our insurance subsidiaries, is monitored by the Office of the Superintendent of Financial Institutions Canada (“OSFI”). OSFI evaluates our financial strength primarily through the MCT, which measures available capital against required risk-weighted capital.

Available capital comprises total equity subject to adjustments prescribed by OSFI. Capital required is calculated by applying risk factors to certain assets and liabilities. As at December 31, 2015, our regulatory capital significantly exceeded the supervisory minimum MCT requirement of 150% required by OSFI, as well as a higher and more stringent internal target established in our capital management policy.

We actively monitor the MCT and the effect that external and internal actions have on our capital base. In particular, management determines the effect on capital before entering into any significant transactions to ensure that policyholders are not put at risk through the depletion of capital to unacceptable levels. The Board of Directors reviews the MCT on a quarterly basis.

Figure 18 shows our MCT ratio as at December 31.

Figure 18 2015 2014

MCT 285.2% 295.4%

Figure 19 shows our regulatory capital position as at December 31. Capital available and capital required included in the figure below are determined in accordance with rules prescribed by OSFI.


Capital available 1,617.0 1,605.9

Capital required 567.1 543.7

MCT % 285.2% 295.4%

Excess capital at 175% 624.7 654.4

Excess capital at 200% 482.9 518.5

We continue to be in a strong position from a solvency standpoint. We regularly monitor our MCT ratio, the results of our annual dynamic capital adequacy stress testing, and periodic stress testing, and seek to ensure that a strong regulatory capital position is maintained and take corrective actions as necessary. Reinsurance is also used to protect our capital from large losses, including those of a catastrophic nature, which could have a detrimental impact on capital. We have formal policies that specify tolerance for financial risk retention. Once the retention limits are reached, reinsurance is utilized to cover the excess risk.

We also have intercompany reinsurance agreements (the “Agreements”) in place, which results in each insurance company subsidiary reporting the same combined ratio. The Agreements are supported by documented agreements between each of the companies and the cash flows resulting from the arrangement are settled on a monthly basis. The Agreements allow the impact of any insurance losses to be spread across each insurance company subsidiary, enabling each subsidiary to maintain a strong capital position without the need to move capital via dividends or capital injections. Further supporting the Agreements, the insurance companies have pooled all of their invested assets into a partnership, The Economical Insurance Group Investment Partnership. The vast majority of invested assets of the companies are held in the partnership with each company owning a share of the partnership generally approximating to its participation in the Agreements described above.

Own Risk and Solvency Assessment (“ORSA”)

The ORSA is a framework for federally regulated insurers to internally assess their risks and determine the level of capital required to support future solvency. The ORSA demonstrates how risk assessment and capital management are integrated into our decision-making process and are monitored to maintain financial viability.

We integrate the ORSA with our enterprise risk management framework, enterprise risk management policies, risk assessment, management reporting and decision-making processes. Our Board of Directors, Risk Review Committee, and Management Risk Committee provide oversight and review of the ORSA, challenging assumptions and results to ensure they are considered appropriate in the circumstances.

We develop the ORSA by reviewing our key risks and identifying key risk indicators, quantitative risk sensitivity and/or stress tests and analyses which could help relate the key risks to capital requirements. This process includes thoroughly assessing OSFI’s



methodology for relating risks to capital as presented in OSFI’s 2015 MCT guideline and determining its appropriateness to our risk profile. As the regulatory method has been developed with consideration to the entire industry, some capital factors are more suitable than others in addressing our risks. Depending on the risk, the regulatory approach is validated and accepted, modified to our circumstances or a new methodology is developed. The output of this effort is the relation of risks to ORSA capital requirements using both quantitative and qualitative methods in a deterministic capital model. Stress testing is then utilized to assess the resiliency of our capital under a range of adverse conditions, including extreme scenarios. The ORSA is integrated into the budgeting and planning process to determine our ability to meet internal and regulatory capital targets in the future, and to identify contingency plans and procedures should capital levels threaten to fall below warning levels.

After reviewing the results of the most recent ORSA and the corresponding ORSA report, which documented the ORSA process, methodology and capital model, we are satisfied that we have sufficient capital to maintain solvency based on our risk profile.

NET RISK RATIO

Another ratio commonly used to measure the stability of insurers is the net risk ratio. The net risk ratio (“NRR”) measures the level of risk relative to capital we have employed, expressing net written premiums for a 12-month period as a ratio to total equity. The OSFI guideline for NRR is 3:1 or less.

Figure 20 shows our NRR as at December 31.

Figure 20 2015 2014

NRR 1.1 1.1

As at December 31, 2015, we had significantly more capital than required to support the volume of business underwritten by our operating companies. The NRR has remained relatively unchanged from December 31, 2014. We are well-positioned from a capital standpoint to support our planned investments and growth in premium levels moving forward.

FINANCIAL STRENGTH RATING

On May 1, 2015, A.M. Best reaffirmed our A- (Excellent) financial strength rating and “a-” issuer credit rating. By extension, Waterloo Insurance Company (branded as Economical Select) had these same ratings reaffirmed. The ratings of A- (Excellent) and “a-” respectively provide further reinforcement of our financial strength and significantly improved financial performance. The outlook for all ratings is stable.

LIQUIDITY

The liquidity requirements of our business are met primarily by funds generated by insurance operations and investment returns. Cash provided from these sources normally exceeds cash requirements to meet claim payments and operating expenses.

As at December 31, 2015, we have $89.0 million (2014: $89.2 million) of cash and cash equivalents. We also have a highly liquid investment portfolio comprising actively traded securities including: Canadian fixed-income investments issued or guaranteed by domestic governments, investment-grade corporate bonds, publicly traded Canadian and foreign equities, and a foreign equity pooled fund with a combined fair value of $3,944.2 million (2014: $3,891.1 million). We believe our internal resources will provide sufficient funds to fulfill cash requirements during the 2016 financial year and to satisfy all regulatory capital requirements. Adherence to the liquidity policy seeks to ensure that we have sufficient cash and highly liquid resources to meet our financial obligations, to support our future growth initiatives, and that excess cash is appropriately invested.

We have no outstanding debt other than bank overdraft operating lines and trade payables.

Figure 21 provides a summary of cash flows for the year ended December 31.

Figure 21 (in millions of dollars, except as otherwise noted) 2015 2014 $ Change

Operating activities

Cash provided by operating activities 119.2 132.1 (12.9)

Investing activities

Investments purchased, net of investments sold (72.7) (111.8) 39.1

Other assets purchased (45.3) (18.4) (26.9)

Business acquisitions (1.3) - (1.3)

Net (decrease) increase in cash and cash equivalents (0.1) 1.9 (2.0)

Cash provided by operating activities decreased in 2015 as compared to 2014, primarily due to an increase in income taxes, claims, and commissions and expenses paid, partially offset by an increase in premiums collected and dividends received. The cash flow from operations allowed us to increase investments during the year and fund our infrastructure and operational investments.



SECTION 8 — COMMITMENTS AND CONTINGENCIES

COMMITMENTS

Our commitments include operating lease commitments and certain non-cancellable contractual commitments. Our motor vehicles, computers and office equipment are supplied through operating leases. The future contractual aggregate minimum lease payments under non-cancellable operating leases and other commitments are outlined in Figure 22 below.


Within 1 year 40.6 37.3

Later than 1 year but not later than 5 years 55.3 56.7

Later than 5 years 13.9 19.9

The total amount of commitments has decreased slightly from the prior year period. Commitments pertaining to building leases declined as there were no renewals during the year, and existing commitments declined with the passage of time. This offset several contracts signed in 2015 to support the development of our policy administration system and other information technology infrastructure investments.

OFF-BALANCE SHEET LIABILITIES AND CONTINGENCIES

In common with the insurance industry in general, we are subject to litigation arising in the normal course of conducting our insurance business. We are of the opinion that this litigation will not have a significant effect on our financial position, results of operations, or cash flows.

We participate in a securities lending program managed by a major Canadian and US financial institution, whereby we lend securities we own to other financial institutions to allow them to meet delivery commitments. The lending agents assume the risk of borrower default associated with the lending activity. As at December 31, 2015, securities with an estimated fair value of $509.3 million (2014: $590.3 million) have been loaned and securities with an estimated fair value of $524.6 million (2014: $603.9 million) have been received as collateral from the financial institutions. Lending collateral as at December 31, 2015 was 100.0% (2014: 100.0%) held in cash and government-backed securities. The securities loaned under this program have not been removed from “Investments” on the consolidated balance sheet because we retain the risks and rewards of ownership.

The financial compensation we receive in exchange for securities lending is reflected in the consolidated statement of comprehensive income in “Interest”.



SECTION 9 — RELATED PARTY TRANSACTIONS

From time to time, we enter into transactions in the normal course of business, which are measured at the exchanged amounts, with certain directors, senior officers and companies with which we are related. Management has established procedures to review and approve transactions with related parties and reports annually to the Corporate Governance Committee of the Board of Directors, on the procedures followed and the results of the review.

At the reporting date, commercial loans of $7.1 million (2014: $1.8 million) are due from companies subject to significant influence. The loans are included in “Investments” in the consolidated balance sheet and are initially measured at the exchange amount. The loans are subsequently measured in accordance with the accounting policy for loans and receivables as noted in Note 2 — ‘Summary of significant accounting policies’, included in our audited consolidated financial statements.

EMPLOYMENT BENEFIT PLANS

The Company provides certain pension and other post-employment benefits through defined benefit, defined contribution and other post-employment benefit plans to eligible participants upon retirement. Information regarding transactions with the plans is included in Note 17 — ‘Post-employment benefits’ included in our audited consolidated financial statements.



SECTION 10 — ACCOUNTING AND INTERNAL CONTROLS

INTERNAL CONTROLS AND PROCEDURES

We have designed and validated key internal controls and procedures to ensure that accurate financial information is available internally to the Board of Directors and senior management, and externally to regulators and policyholders, in a timely and appropriate manner. Inherent limitations exist in all control systems and, as such, an evaluation of those control systems can provide only reasonable assurance that fraud or errors are detected. We continue to monitor, assess and improve our system of internal controls and procedures.

CRITICAL ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS

The preparation of our audited consolidated financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingent assets and liabilities as at the reporting date and the reported amounts of revenues and expenses during the year. Actual results could differ from these estimates. Although some variability is inherent in these estimates, management believes that the amounts provided are reasonable. Our significant accounting policies are discussed in Note 2 — ‘Summary of significant accounting policies’ to the audited consolidated financial statements.

The most complex and significant judgments, estimates and assumptions used in preparing our audited consolidated financial statements are discussed below.

Judgments

In the process of applying our accounting policies, management has made the following judgments, which have the most significant effect on the amounts recognized in the audited consolidated financial statements.

We have applied judgment in our assessment of control or significant influence over investees, of the identification of objective evidence of impairment for financial instruments, the recoverability and recognition of tax losses, the determination of cash-generating units, the evaluation of current obligations requiring provisions and the identification of the indicators of impairment for property and equipment, goodwill and intangible assets.

Estimates and assumptions

The key assumptions concerning the future and other key sources of estimation uncertainty at the reporting date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are discussed below.

Valuation of claim liabilities

We are required by applicable insurance laws, regulations and IFRS to establish liabilities for payment of claims and claims adjustment expenses that arise from our insurance products. These liabilities represent the expected ultimate cost to settle claims occurring prior to, but still outstanding as of, the reporting date. We establish our claim liabilities by geographic region, product line, type and extent of coverage and year of occurrence.

Claim liabilities fall into two categories: reserves for reported claims and provision for incurred but not reported (“IBNR”) losses. Additionally, liabilities are held for claims adjustment expenses, which contain the estimated legal and other expenses expected to be incurred to finalize the settlement of the losses.

Determining the provision for unpaid claims and adjustment expenses and the related reinsurers’ share involves an assessment of the future development of claims. The estimates are principally based on our historical experience. Methods of estimation have been used that we believe produce reasonable results given current information. This process takes into account the consistency of our claim handling procedures, the amount of information available, the characteristics of the line of business from which the claim arises, and the delays in reporting claims. Claim liabilities include estimates subject to variability, which could be material. Changes to the estimates could result from future events such as receiving additional claim information, changes in judicial interpretation of contracts or significant changes in severity or frequency of claims from past trends.

In general, the longer the term required for the settlement of a group of claims, the greater the potential for variability in the estimate. Any future changes in estimates would be reflected in the consolidated statement of comprehensive income in the year in which the change occurred.

The principal assumptions made in establishing claim liabilities are best estimates. Claim liabilities have been discounted to reflect future investment income in accordance with Canadian accepted actuarial practice. The rate used to discount the claim liabilities is based on the fair value yield of the bond portfolio supporting the claim liabilities. To increase the likelihood that the claim liabilities are adequate to pay future benefits, margins for adverse deviation are required to be included for assumptions regarding future claims development, interest rates and reinsurance recoverables. The Canadian Institute of Actuaries recommends a range of appropriate margins for each of these variables. The combined effect of all the margins produces the PfAD.



Reinsurance recoverables include amounts for expected recoveries from reinsurers related to claim liabilities. Amounts recoverable from reinsurers are evaluated in a manner consistent with the provisions of the reinsurance contracts. The failure of reinsurers to honour their obligations could result in losses, as the ceding of insurance does not relieve us of our primary liability to our insured parties.

Impairment of goodwill and intangible assets

We determine whether goodwill and intangible assets are impaired on an annual basis or more frequently if there are indicators of potential impairment. Impairment testing of goodwill and intangible assets requires an estimation of the recoverable amount of the cash-generating units to which the assets are allocated.

Impairment of financial assets

We assess our AFS financial instruments for objective evidence of impairment at each reporting date. Objective evidence of impairment includes a significant or prolonged decline in the fair value or net asset value below cost or when a loss event that has a reliably estimable impact on the future cash flows of the financial instrument has occurred. Significance of the decline is evaluated against the original cost of the investment and prolonged against the period in which the fair value has been below its original cost. The determination of what is significant or prolonged requires judgment. In making this judgment, we evaluate, among other factors, a decline in current financial position; defaults on debt obligations; failure to meet debt covenants; significant downgrades in credit status; and severity and/or duration of the decline in value.

Control or significant influence over investees

We presume that control or significant influence over an investee is evidenced primarily by the ownership percentage held of the investee unless there are other factors which indicate the level of control is not aligned with the ownership percentage. Currently there are no investments in investees for which the assessment of control or significant influence is not aligned with the ownership percentage.

Valuation of post-employment benefits obligation

We provide certain pension benefits through a pension plan with a defined benefit and a defined contribution component. We also provide a non-pension future benefit plan. The projected cost of defined benefit pension plans and other non-pension future benefits is determined using actuarial valuations performed by external pension actuaries. No estimation is required for the defined contribution pension plan given the plan structure. The actuarial valuation involves making assumptions about discount rates, future salary increases, mortality rate, expected health care costs, inflation and future pension increases. Due to the long-term nature of these plans, such estimates are subject to significant uncertainty. Actual experience that differs from the assumptions will affect the amounts of the benefit obligation recognized in the consolidated balance sheet, the expense recognized in net income and actuarial gains or losses recognized in OCI in the consolidated statement of comprehensive income.

Provisions

Provisions, including restructuring provisions, are recognized when we determine that there is a present legal or constructive obligation as a result of a past event or decision, it is more likely than not that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Provisions are recorded at the present value of the expenditures expected to be required to settle the obligation. In estimating provisions, we must make assumptions regarding the timing and amount of the expenditures and determine an appropriate discount rate reflective of the current market assessment of the time value of money and the risks specific to the obligations.

Measurement of income taxes

We are subject to income tax laws in various federal and provincial jurisdictions where we operate. Various tax laws are potentially subject to different interpretations by the taxpayer and the relevant tax authority. To the extent that our interpretations differ from those of tax authorities or the timing of realization is not as expected, the provision for income taxes may increase or decrease in future periods to reflect actual experience. We maintain provisions for uncertain tax positions that we believe appropriately reflect the risk of tax positions under discussion, audit dispute or appeal with tax authorities or which are otherwise considered to involve uncertainty.

FUTURE ACCOUNTING AND REPORTING CHANGES

The following IFRS standards have been issued but are not yet effective. We are currently analyzing the impact these standards will have on our audited consolidated financial statements, unless otherwise stated.

(a) Financial Instruments: Classification and Measurement

In July 2014, the IASB issued the final version of IFRS 9 — Financial Instruments (“IFRS 9”), which reflects all phases of the financial instruments project and replaces IAS 39 — Financial Instruments: Recognition and Measurement and all previous versions of IFRS 9. IFRS 9 sets out the requirements for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. This single, principle-based approach replaces existing rule-based requirements and is intended to improve and simplify the reporting for financial instruments. IFRS 9 is effective for annual periods beginning on or after January 1, 2018. Retrospective application is required with certain exceptions.

Proposed amendments to IFRS 4 — Insurance Contracts were issued in December 2014 and have an expected effective date for years beginning on or after January 1, 2018. The amendments propose an optional temporary exemption from applying IFRS 9 that would be available to companies whose predominant activity is to issue insurance contracts. Such a proposal permits deferral of IFRS 9 application until annual periods beginning on or after January 1, 2021 or until the new insurance contract standard becomes effective if this is an earlier date. The amendments also propose an option to apply the “overlay approach” to the presentation of qualifying financial assets, in which an entity would be permitted to remove from profit or loss and present instead in OCI, the impact of measuring financial assets at fair value through profit or loss under IFRS 9 when they would not have been so measured under IAS 39.



(b) Revenue from Contracts with Customers

In May 2014, the IASB issued IFRS 15 — Revenue from Contracts with Customers, which clarifies the principles for recognizing revenue and cash flows arising from contracts with customers. The standard is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively. The Company does not expect the standard to have a material impact on its consolidated financial statements.

(c) Leases

In January 2016, the IASB issued IFRS 16 — Leases, which establishes principles for the recognition, measurement, presentation and disclosure of leases. The standard provides a single lessee accounting model, requiring lessees to recognize assets and liabilities for all leases, unless the lease term is twelve months or less or the underlying asset has a low value. The standard is effective for annual periods beginning on or after January 1, 2019 and is to be applied retrospectively.



SECTION 11 — FINANCIAL INSTRUMENTS

Financial instruments are initially recognized at fair value and are subsequently accounted for at fair value or amortized cost depending on the financial instrument classification. The classification depends on the purpose for which the financial instruments were acquired and their characteristics. The fair value of a financial instrument on initial recognition is normally the transaction price, i.e. the fair value of the consideration given.

Subsequent to initial recognition, the fair values are determined based on available information. Financial instruments classified as FVTPL or AFS are carried at fair value, while all others are carried at amortized cost. The fair values of investments, excluding commercial loans, are based on quoted bid market prices where available or observable market inputs. Observable market inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in inactive markets, inputs that are observable but are not prices such as interest rates and credit risks and inputs that are derived from or corroborated by observable market data. The fair values of commercial loans and other financial instruments are measured at amortized cost using the effective interest rate method.

All short-term investments, equities (including preferred stocks, common stocks and pooled funds) and bonds, except those voluntarily designated as FVTPL, are designated as AFS. Changes in fair value are recorded, net of income taxes, in OCI in the consolidated statement of comprehensive income until the disposal of the financial instrument, or when an impairment loss is recognized. When the financial instrument is disposed of, the gain or loss is reclassified from accumulated other comprehensive income to recognized gains on investments in the consolidated statement of comprehensive income.

We have voluntarily designated a portion of our bonds as FVTPL. We have no other significant FVTPL financial assets. Changes in fair values as well as gains and losses on disposal of FVTPL financial instruments are recorded in recognized gains on investments in the consolidated statement of comprehensive income with the related tax impact included in income tax expense. Gains and losses on the sale of FVTPL financial instruments are calculated on an average cost basis. Changes in the fair value of the FVTPL financial instruments are reflected within net income in the consolidated statement of comprehensive income, so it is not necessary to record an impairment loss when there has been a significant or prolonged decline in the fair value of FVTPL financial instruments.

The designation of the FVTPL bond portfolio aims to reduce the accounting mismatch in net income that would otherwise be generated by the fluctuations in fair values of underlying claim liabilities due to changes in interest rates. In compliance with OSFI guidelines, we manage the FVTPL portfolio’s quantum and duration so that the impact of changes in interest rates on claim liabilities and the FVTPL portfolio reasonably offset each other.

Bonds and short-term investments are valued on a discounted cash flow basis. The inputs into the discounted cash flow model for the bonds and short-term investments are an estimate of the expected cash flows discounted at a pre-tax risk-free rate plus an appropriate adjustment for credit risk.

Note 2 — ‘Summary of significant accounting policies’, and Note 5 — ‘Investments’, of the audited consolidated financial statements provide further details pertaining to the classification and measurement of our financial instruments.

For a discussion of risks and the management of our risks refer to Section 12 — ‘Risk management’, Investment-related risks, included in our MD&A below.



SECTION 12 — RISK MANAGEMENT

OBJECTIVES

Our enterprise risk management framework is designed to ensure that (i) the outcomes of activities involving risk are consistent with our governing objective, risk management capabilities, risk-taking capacity and risk appetite and (ii) we maintain an appropriate risk and reward balance to protect us from events that have the potential to materially impair our financial strength. Our enterprise risk management framework is rooted in the understanding that we are in the business of taking risk for an appropriate return. Balancing risk and reward is achieved through aligning risk appetite with business strategy, diversifying risk, pricing appropriately for risk, mitigating risk through preventive controls and transferring risk to third parties.

ALIGNMENT

We align our risk tolerance with our overall vision, mission and business goals by considering whether risks are core, non-core or collateral in nature.

Core risks are those risks that we are willing to accept in order to achieve return expectations and successfully achieve our business objectives. These include insurance related risks, credit risk and investment related risks. Non-core risks are those associated with activities outside of our risk appetite and approved business strategies and are therefore generally avoided, regardless of expected returns. Collateral risks are those that are incurred as a by-product of pursuing the risk and return optimization of core risks. Operational risks often fall into this category. We endeavour to mitigate collateral risks to the extent that the benefit of risk reduction aligns with or exceeds the cost of mitigation.

Our risk appetite is also aligned with our risk management capabilities. We actively seek profitable risk-taking opportunities in those areas where we have established risk management capabilities, and seek to avoid risks that are beyond those capabilities.

ACCOUNTABILITY

Our enterprise risk management framework defines responsibility and authority for risk-taking, governance and control.

Risk management occurs at all levels of the organization and is the responsibility of every employee. However, our Board of Directors is ultimately responsible for ensuring that enterprise risk management policies and practices are in place and operating effectively. The Board of Directors, through the Risk Review Committee, reviews the development and maintenance of the ORSA, approval of the risk management policies, the identification of major areas of risk facing us, the development of risk management strategies, and compliance with the risk management policies we implement. To assist in fulfilling the responsibility for ensuring that the principal risks facing us are appropriately identified, challenged, and managed, the Board of Directors has delegated certain risk management functions to the following standing Board of Directors’ committees:

• Risk Review Committee, which is composed entirely of independent directors, is responsible for the oversight of the enterprise-wide risk management framework and the regulatory compliance management program. This includes the development and implementation of ORSA, and enterprise risk management policies, governing objectives and articulation of risk appetite, together with monitoring our key and emerging risks and the results of our regulatory compliance management program.

• Investment Committee, which is composed of a majority of independent directors, is responsible for the oversight of investment policies, practices, procedures and controls related to the management of the investment portfolio, the performance of the investment portfolio and monitoring the investment performance of our pension plans.

• Corporate Governance Committee, which is composed entirely of independent directors, is responsible for developing effective corporate governance guidelines and processes; reviewing policies and processes to sustain ethical behaviour; assessing the effectiveness of the Board of Directors and its committees as well as the contributions of individual directors; and identifying and recommending for election as directors those individuals with appropriate competencies, skills and experience.

• Audit Committee, which is composed entirely of independent directors, is responsible for overseeing the integrity of our financial statements and related public disclosure; the qualifications, independence and appointment of our internal and external auditor; the design, implementation and evaluation of our internal controls over financial reporting and our disclosure controls; and the work of our internal and external auditors.

• Human Resources and Compensation Committee, which is composed entirely of independent directors, is responsible for supervising our human resources practices and policies. This includes reviewing our overall compensation philosophy, approving compensation to our senior executives, and reviewing retention, development and succession plans.

We have implemented a three line of defence risk governance model, consisting of: front line risk-taking through business operations (first line); the enterprise risk management and compliance functions (second line); and internal audit (third line). Primary accountability for enterprise risk management resides with our President and Chief Executive Officer, who further delegates responsibilities throughout the Company under a framework of management authorities and responsibilities. Key components of that framework include:

First line of defence

Business management provide day-to-day management and risk control:

• Employees within each functional and business area identify, take and manage risk on a daily basis, adhering to the Board of Directors’ approved risk appetite statements and supporting policies and practices.



• Accountable executives within each functional and business area establish and perform ongoing monitoring and oversight of functions and controls to review employee compliance with our risk management policies and practices. These individuals are supported by corporate legal, compliance and enterprise risk management resources, and include the following roles:

• Corporate office functional heads, namely the Chief Financial Officer, Chief Actuary and Chief Strategy Officer, who collaborate with the Chief Risk Officer, who also fulfills the role of Chief Compliance Officer, and the Management Risk Committee in the development, communication and implementation of our enterprise risk management framework.

• Chief Underwriting Officer, who establishes, oversees and implements our underwriting and pricing policies and guidelines.

• Chief Operating Officer, who has overall front line accountability for managing the risks in the operations in accordance with our enterprise risk management framework and how we distribute our products.

• Chief Information Officer, who has overall front line accountability for the operation of our information systems and managing the information technology-related risks in accordance with our enterprise risk management framework.

• Chief Human Resources Officer, who establishes, oversees and implements our Human Resources policies and activities.

• Vice-President Claims, who establishes, oversees and implements our claims handling policies and guidelines.

• Vice-President Investments, who establishes, oversees and implements our investment policies and guidelines.

Second line of defence

Risk and compliance functions provide risk policies, tools, methodologies and oversight:

• The Chief Risk Officer, whose responsibilities include providing independent functional oversight of our enterprise risk management programs by ensuring that effective risk management processes are in place for risk identification, risk measurement and assessment, risk response development, risk monitoring and control, and reporting of risks inherent in our activities.

• The enterprise risk management function, headed by the Chief Risk Officer, who also fulfills the role of Chief Compliance Officer, establishes enterprise risk policies and provides direction, processes, methodologies, models and tools to the Company. It performs independent monitoring and analysis of risk-taking by the first line of defence and its risk management activities. Through the ORSA, the enterprise risk management function internally assesses our risks and determines the level of capital required to support future solvency. The compliance function communicates internal and external compliance requirements to the first line of defence and provides support to help the first line of defence ensure compliance with those requirements through the regulatory compliance management program.

• The enterprise risk management and compliance functions’ own quality assurance and validation practices are applied to ensure that policies, methodologies, practices, models, frameworks and other capabilities developed by enterprise risk management comply with requirements and quality standards and are suitable for use within the Company.

• Our Management Risk Committee is a cross-functional management committee composed of the President and Chief Executive Officer and members of senior management. It is led by the Chief Risk Officer and oversees the management of major enterprise risk and control activities with a view to understanding existing and emerging risks, their impact on our risk profile, capital requirements, and ensuring that the magnitude of those risks remains within the Board of Directors’ approved risk parameters.

Third line of defence

Internal audit provides periodic independent assurance:

• Internal audit provides periodic independent assurance on the adequacy and effectiveness of enterprise risk management policies, the supporting framework and related processes and practices, as well as compliance with policies, standards and required practices, taking into account the relative risk in each area of coverage.

• Internal audit has its own quality assurance and validation practices and applies them to ensure that internal audits are carried out in compliance with established audit policies, standards and methodologies and that audit findings and conclusions are objective and appropriately supported.

MANAGEMENT OF CORE RISKS

The key risks we manage include insurance related risks, credit risk, investment related risks, strategic risk, and operational and other risks, which are explained in greater detail below and should be considered carefully. Although we have described those risks that we believe to be material, it is possible that other risks and uncertainties may exist. If any of these risks or any other risks or uncertainties actually occur it is possible that our business could be materially affected in an adverse manner. Our enterprise risk management framework cannot anticipate every risk in all environments, nor the timing or effect of every such risk.

Insurance related risks

Product and pricing risk

Product and pricing risk is the risk of financial loss from entering into insurance contracts when the liabilities assumed exceed the expectation reflected in the pricing of the insurance product. We price our products by taking into account several factors including product design and features, claim frequency and severity trends, product line expense ratios, special risk factors, capital requirements, regulatory requirements and investment income. These factors are reviewed and adjusted as needed to ensure they are reflective of current trends and market conditions. We endeavour to maintain pricing levels that produce an acceptable return by appropriately measuring and incorporating these factors into our pricing decisions.



New products are subject to a detailed review by management, including our actuarial specialists, prior to their launch in order to mitigate the risk that they are priced at an inadequate level. The performance and pricing of such new products are regularly monitored and corrective action is taken as considered necessary, including re-pricing of the products and the use of reinsurance.

New or potential legislative or industry developments could affect our ability to price some of our products at an adequate level and restrict our ability to make a reasonable return.

Underwriting risk

Underwriting risk is the risk of financial loss resulting from the selection of risks to be insured and the management of contract clauses. To minimize underwriting risk, we have underwriting policies that set out our underwriting risk appetite and criteria, as well as specifying tolerances for maximum financial risk retention. Once the retention limits are reached, reinsurance is utilized to cover the excess risk. We review the adequacy of our reinsurance programs, at least annually, to ensure sufficient reinsurance protection is in place at an appropriate cost.

Quality review procedures exist to ensure that our underwriting activities fall within established guidelines, risk appetites, and pricing structures. Head Office and field level reviews are conducted on a sampled basis. The results of these quality reviews are shared with the appropriate field management staff to ensure any issues identified are remedied.

Our underwriting results may also be adversely impacted by our mandatory participation in the Facility Association of Canada’s (“FA”) automobile insurance pools. When certain automobile owners are unable to obtain insurance via the voluntary insurance market, they are insured by the FA. In addition, insurance entities can choose to cede certain risks to FA-administered risk sharing pools (“RSP”) or in Quebec, the Plan de Repartition des Risques (“PRR”). The related risks associated with FA insurance policies and policies ceded by companies to the RSP are aggregated and shared by the entities in the P&C insurance industry, generally in proportion to market share and volume of business ceded to the RSP.

Claims risk

Claims risk is the risk that inappropriate claims payments are made as a result of inadequate adjudication, settlement or payment of claims. Strict claim review policies are in place to assess all new and ongoing claims, but it is nonetheless possible that certain claims are paid out in inappropriate circumstances. In addition, our regular detailed review of claims handling procedures and frequent investigation of possible fraudulent claims attempts to manage our claims risk exposure by assessing how we can improve our procedures to reduce the payout of inappropriate claims and investigating whether a particular claim should be denied in the circumstances, respectively. We attempt to reduce our exposure to unpredictable future developments that could negatively impact claims settlement by promptly responding to new claims and actively managing existing claims, thereby shortening the claims cycle.

Claims reserving risk

A key objective of the Company is to ensure that sufficient claim liabilities are established to cover future insurance claim payments. Our underwriting profitability depends upon our ability to accurately assess the risk associated with the insurance contracts underwritten by us. We establish claim liabilities to cover the estimated liability for payment of all claims and claims adjustment expenses incurred with respect to insurance contracts underwritten by us. Claim liabilities do not represent an exact calculation of the liability. Rather, claim liabilities are our best estimate of the expected ultimate cost of resolution and administration of claims. The process of calculating claim liabilities involves the use of models, which exposes us to model risk in the event that actual results differ from those modelled, due to model limitations, data issues or other factors. Expected inflation is taken into account when estimating claim liabilities, thereby mitigating inflation risk.

Claim liabilities include an estimate for reported claims as established by our claims adjusters based upon the details of reported claims, plus a provision for IBNR.

Individual claims estimates are determined by claims adjusters on a case-by-case basis in accordance with documented policies and procedures. These specialists apply their knowledge and expertise, after taking available information regarding the circumstances of the claim into account, to set individual case reserve estimates. The case reserving strategy and monitoring of their application and effectiveness falls under the accountability of the claims department. The IBNR provision, which falls under the accountability of corporate actuarial, is intended to cover future development on both reported claims and claims that have occurred but have not yet been reported. Uncertainty exists on reported claims in that all information may not be available at the valuation date. Uncertainty also exists regarding the number and size of claims not yet reported as well as the timing of when the claims will be reported. Claim liability estimates are reviewed by our Appointed Actuary, including for purposes of delivering the Appointed Actuary’s report.

The valuation of claim liabilities is based on estimates derived by geographical region and line of business using generally accepted actuarial techniques. Numerous individual assumptions that impact average claim costs or frequency of late reported claims are made for each line of business. The principal assumption in the majority of actuarial techniques employed is that future claims development will follow a pattern similar to recent historical experience. However, there are times where historical experience is deemed inappropriate for evaluating future development due to recent judicial decisions, changes to government legislation or major shifts in a book of business. Such instances can require significant actuarial judgment, often supported by industry benchmarks, in establishing an adequate provision for claim liabilities.



Establishing an appropriate level of claim liabilities is an inherently uncertain process and is closely monitored by our corporate actuarial department. The sheer volume and diversity of considerations makes it impracticable to measure the impact on our insurance contracts resulting from a change in a particular assumption or group of assumptions. The analysis below demonstrates the impact of changing assumptions for all lines of business and geographical regions in such a way that the average claims severity and frequency is altered materially. The analysis below also isolates the impact within the average claims severity of a change in internal claims expenses on claim liabilities. The impacts below are on the reported claim liabilities as at December 31.

(in millions of dollars)

Impact of change in net claim liabilities due to:

2015 2014

5% -5% 5% -5%

Change in average claims severity $ 111.9 $ (111.9) $ 113.8 $ (113.8)

Change in frequency on unreported claims $ 8.3 $ (8.3) $ 6.2 $ (6.2)

Change in internal claims expenses $ 6.6 $ (6.6) $ 6.7 $ (6.7)

As the outstanding claim liabilities represent payments that will be made in the future, they are discounted to reflect the time value of money, effectively recognizing that the bonds held to support insurance liabilities will earn a return during that period. The discount rate used to discount the actuarial value of claim liabilities is based on the fair value yield of the bonds that support the claim liabilities. In assessing the risks associated with investment income and therefore the discount rate, we consider the nature of the bond portfolio and the timing of claim payments and their matching to investment cash flows. Future changes in the bond portfolio could change the value of claim liabilities by impacting the fair value yield. The following table presents the interest rate sensitivity analysis for a 1% change in interest rates on the net claim liabilities:


Impact on:

2015 2014

1% -1% 1% -1%

Net claim liabilities $ (67.3) $ 72.5 $ (66.7) $ 71.7

Assumptions and methods of estimation have been used that we believe produce reasonable results given current information. As additional experience and other data become available, the estimates could be revised. Any future changes in estimates would be reflected in the consolidated statement of comprehensive income in the year in which the change occurred. To increase the likelihood that the claim liabilities are adequate to pay future benefits, margins for adverse deviation are included for assumptions regarding future claims development, interest rates and reinsurance recoverables.

Catastrophe risk

Catastrophe risk may arise if we experience large losses due to man-made or natural catastrophes that can result in significant impacts on claims costs. Catastrophes can cause losses in a variety of different lines of business and may have continuing effects which, by their nature, could delay or impede efforts to accurately assess the full extent of the damage they cause on a timely basis. Although we evaluate catastrophe events and assess the probability of occurrence and magnitude of impact through various commonly used, industry-wide modelling techniques and through the aggregation of limits exposed in each geographical territory in which we operate, such events are inherently unpredictable and difficult to quantify. In addition, the incidence and severity of catastrophe events may become increasingly unpredictable as climate patterns change, and severe weather caused by climate change will likely continue to affect the P&C industry and result in higher claims costs. Catastrophe events may also result in increased assessments from the Property and Casualty Insurance Compensation Corporation (“PACICC”), leading to further costs.

We manage our catastrophe events exposure through the deductibles charged to policyholders, managing the geographic concentration of our policies, purchasing reinsurance, and monitoring the impact on capital position and overall risk tolerances. We currently purchase reinsurance to provide coverage for catastrophe events, both on an aggregated and individual basis. Nonetheless, the occurrence of catastrophe events could negatively impact our business performance and financial results.

Reinsurance coverage risk

We utilize reinsurance in order to manage our exposure to insured risks. Reinsurance coverage risk arises because reinsurance terms, conditions, availability and/or pricing may change on renewal, particularly during times of high levels of catastrophe events, either in Canada or globally, or as a result of higher than expected claims activity on the non-catastrophe reinsurance treaties. In addition, reinsurers may seek to impose terms that are inconsistent with corresponding terms in the policies written by us. Ceding risk to reinsurers does not relieve us of the obligation to our policyholders for claims. We work only with well-established and financially secure reinsurers that have extensive experience in the P&C insurance industry as well as a strong understanding of our business and the Canadian environment. Senior management reviews our reinsurance program to ensure its cost effectiveness and that adequate coverage is obtained, reflective of our risk tolerances and financial strength, and in compliance with our reinsurance and capital risk management policies. Refer to Note 9 — ‘Reinsurance contracts’, included in our audited consolidated financial statements, for a summary of our retentions and maximum limits.

Credit risk

Credit risk is the risk of financial loss caused by our counterparties not being able to meet payment obligations as they become due. Our credit risk is concentrated in the bond, preferred stock and commercial loan portfolios, the securities lending program, premiums receivable, amounts owing from reinsurers and structured settlements. Unless otherwise stated, our credit exposure is limited to the carrying amount of these assets.



Our investment policy requires that we invest in bonds and preferred stocks of high credit quality and limit exposure with respect to any one issuer. On a regular basis, we also monitor publicly available information referencing the investments held in the investment portfolio to determine whether there are investments which require closer monitoring of the credit risk. Refer to Section 6 — ‘Financial condition’ for further details pertaining to our investment portfolio credit ratings and investment mix.

We participate in a securities lending program managed by a major Canadian and US financial institution, whereby we lend securities we own to other financial institutions to allow them to meet delivery commitments. Refer to Section 8 — ‘Commitments and contingencies’ for further discussion.

Our credit exposure to any one individual policyholder or broker included in premiums receivable is not significant. We regularly monitor amounts due from policyholders and follow up on all overdue accounts. As permitted by regulation, when premiums are overdue for an extended period of time we cancel the insurance coverage under the applicable policy. Before a broker is granted a contract, we conduct appropriate reviews. Delinquent accounts are regularly monitored and we take action against non-payment.

We periodically issue commercial loans to our brokers. Sufficient collateral, in the form of an assignment over the ownership interest in the brokerage, is held to protect us against default on these loans. Annual financial reviews are undertaken to determine if the broker will be able to make the required payments when due. Our gross credit exposure on these loans is limited to the carrying value of commercial loans, which amounted to $25.0 million as at December 31, 2015 (2014: $38.1 million). There is currently no evidence of significant impairment of any individual commercial loan.

Credit exposures on our reinsurance receivable and recoverable balances exist to the extent that any reinsurer may or may not be willing or able to reimburse us under the terms of the relevant reinsurance arrangements. We have policies which limit the exposure to individual reinsurers and we have a regular review process to assess the creditworthiness of reinsurers from whom we purchase coverage. Our reinsurance risk management policy generally precludes the use of reinsurers with credit ratings less than “A-”. Currently all reinsurers have a credit rating of “A-” or better as determined by independent rating agencies. Where appropriate, we obtain collateral for outstanding balances in the form of cash, letters of credit, offsetting balances payable, guarantees or assets held under reinsurance security agreements.

We have purchased annuities from life insurers to provide for fixed and recurring payments to claimants. As a result of these arrangements, we are exposed to credit risk to the extent to which any of the life insurers fail to fulfill their obligations. This risk is managed by acquiring annuities from life insurers with proven financial stability, all of which are rated “A-” or better by independent rating agencies. As at December 31, 2015, no information has come to our attention that would suggest any weakness or failure in life insurers from which we have purchased annuities. Consequently, no provision for credit risk is required. The original purchase price of the outstanding annuities is $271.9 million (2014: $262.0 million). The annuities are purchased from multiple life insurers to reduce our ultimate credit exposure.

Investment related risks

Our investment holdings are exposed to interest rate risk, equity market price risk, credit risk (as previously discussed) and foreign exchange risk.

We have established a detailed investment policy statement for the investment portfolio, which is subject to regular review and approval. The policy statement sets out our philosophy to investment management, which is to generate sufficient income while preserving capital. The philosophy focuses on maximizing our long-term capital strength, while seeking to maximize risk adjusted returns. The policy statement includes specific guidelines over such items as asset mix, concentration levels in specific investments, required quality of the underlying investments, the use of derivatives and exposure to foreign currencies. Compliance with these guidelines, and the requirements of the Insurance Companies Act (Canada), is routinely monitored by management and reported to the Investment Committee.

Interest rate risk

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows or the fair values of financial instruments. Typically, interest income will be reduced during sustained periods of declining interest rates, but this will also generally increase the fair value of the bond portfolio. The reverse is true during a sustained period of increasing interest rates. As interest rate risk is a significant risk to us due to the nature of our investments and claim liabilities, a portion of our bond portfolio has been voluntarily designated as FVTPL financial assets, and this plus a portion of AFS bonds is managed to mitigate the effect of interest rate changes on our claim liabilities.

The impact of an immediate hypothetical 1% change in interest rates, on the FVTPL and AFS bond portfolios, with all other variables held constant is as follows:


Impact on:

2015 2014

1% -1% 1% -1%

Fair value of FVTPL bonds and income before income taxes $ (67.0) $ 74.2 $ (66.6) $ 72.5

Fair value of AFS bonds and OCI before income taxes $ (62.3) $ 75.1 $ (43.9) $ 51.3

As discussed under ‘Claims reserving risk’, an immediate hypothetical 1% increase in the discount rate would reduce net claim liabilities, and increase income before income taxes, by $67.3 million (2014: $66.7 million). This would almost entirely be offset by the corresponding decrease in income before income taxes on the FVTPL bond portfolio discussed above of $67.0 million (2014: $66.6 million).



Common equity market price risk and preferred stock price risk

As part of our investment portfolio, a portion of the investments are held in equity investments in Canadian and foreign stocks. Economic trends, the political environment and other factors can positively or adversely impact the equity markets and consequently the value of equity investments we hold. Our AFS portfolio includes Canadian common stocks with fair value movements that are benchmarked against movements in the Toronto Stock Exchange Composite Index, and foreign stocks and pooled funds with fair values that are benchmarked against movements in the Morgan Stanley Capital International Index. Also included in the AFS portfolio are the Company’s holdings of preferred stocks.

The impact of a 10% movement in equity markets to the value of our equity portfolio, with all other variables held constant, to the extent we do not dispose of any of these equities during the year, is as follows:


Impact on:

2015 2014

10% -10% 10% -10%

Fair value of Canadian stocks and OCI before income taxes $ 34.9 $ (34.9) $ 22.0 $ (22.0)

Fair value of preferred stocks and OCI before income taxes $ 37.1 $ (37.1) $ 41.2 $ (41.2)

Fair value of foreign stocks, pooled funds and OCI before income taxes $ 24.7 $ (24.7) $ 21.8 $ (21.8)

Foreign exchange risk

Foreign exchange risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates. Our foreign exchange risk relates primarily to our foreign common stock and pooled fund holdings in the AFS portfolio, which are denominated in various foreign currencies.

Our only significant foreign currency exposure is the US dollar. The table below summarizes the impact on the fair value of (1) US dollar foreign stocks, pooled funds and OCI before income taxes from a 10% change in the US dollar relative to the Canadian dollar; and (2) under this same scenario, the impact on the fair value of non-US dollar foreign stocks, pooled funds and OCI before income taxes from a 10% change assuming historical correlations between currency pairs remain intact.


Impact on:

2015 2014

10% -10% 10% -10%

Fair value of USD foreign stocks, pooled funds and OCI before income taxes $ 11.2 $ (11.2) $ 9.0 $ (9.0)

Fair value of non-USD foreign stocks, pooled funds and OCI before income taxes $ 6.1 $ (6.1) $ 4.9 $ (4.9)

Derivatives risk

Generally, our investment policies limit the use of derivative instruments, without prior Investment Committee approval. Our current use of derivative instruments is negligible. In addition, we conduct a search for embedded derivatives on at least an annual basis, and have found no significant embedded derivatives in 2015.

Strategic risk

Strategic risk is the potential for loss or under-performance arising from the ineffective implementation of appropriate business strategies and/or the inability to adapt strategies to changes in the business environment. Our strategy, and our ability to develop and implement the strategy, is influenced by, amongst other things, industry competition, changes in the regulatory environment or requirements, general economic conditions and legal matters. We closely monitor the environment in which we operate and risks that impact the execution of our strategy are regularly assessed, managed and addressed by the executive leadership team, with oversight from the Board of Directors. Each year the executive leadership team reassesses our strategy in light of industry, general economic, regulatory, technological and other conditions and develops a detailed business plan which is reflective of this strategy. The business plan is presented to and approved annually or more frequently if required, by the Board of Directors.

Key employee risk

Successful implementation of our strategy depends, among other matters, on our ability to attract, develop and retain key employees. The loss of services of key employees could adversely impact our financial performance or the ability to execute on strategic initiatives. To mitigate this risk, we have in place succession plans for our senior executives, which are reviewed on an annual basis. We continue to strengthen our Board of Directors and executive leadership team, and focus on the delivery of critical talent management and performance enhancement programs.

Business, economic and political environment risk

Our business and results can be affected significantly by changes in the business, economic and political environment, including: changes in the level of demand for insurance due to depressed economic conditions, resulting in fewer individuals and businesses purchasing insurance products, such individuals allowing their existing products to lapse, or reductions in policy coverage.

Increased political and governmental involvement in the insurance industry may otherwise change the business and economic environment in which we operate. Such changes could cause us to make unplanned modifications of our products or services, or result in other industry participants altering their strategies in a manner that increases competition in our target markets.



Competition risk

The financial performance of the P&C industry has historically tended to fluctuate in cyclical patterns of “soft” markets characterized generally by increased competition resulting in lower premium rates, followed by “hard” markets characterized by reduced competition and increasing premium rates. The risk exists that these fluctuations in industry conditions could produce an underwriting environment that negatively impacts our underwriting results, premium levels and financial condition.

When there is intense competition in the P&C industry for any product line, our competitors may price their products at rates that appear to be below the level required to make a reasonable return in an effort to gain or retain market share. If we are unable to realize superior risk selection or sufficient expense efficiencies, our ability to establish or maintain competitive pricing could be adversely affected. Given our disciplined approach to underwriting, there may be market conditions or competitive actions which restrict our ability to grow or maintain our written premium levels.

The entrance of new market participants or a shift in the methods to price insurance by competitors could also undermine our ability to establish or maintain competitive pricing. The introduction of disruptive innovations and changing technologies could affect the way that our customers purchase insurance, how we price insurance, the demand for our products, and our underwriting and other decision-making processes. Our ability to effectively compete may be impaired if we do not respond adequately to new market participants or existing competitors who deploy such technologies.

Distribution risk

In order to meet our overall strategy, we must manage our distribution risk. Distribution risk includes the inherent risk of dealing with independent brokers and new market entrants, as well as the risk that the broker distribution channel would not be viable in a specific market. Changes to customer preferences for different distribution channels, including an increasing preference for directto-consumer policies (direct distribution), could lead to a material decline in our market share.

We write products primarily through a network of select brokers across Canada. The ability of our broker network to be competitive against other distributors and our ability to maintain a strong relationship with the brokers, is critical for staying competitive in the market. The competitive environment is further complicated by the consolidation of brokers, and the acquisition of brokers by other P&C insurance companies, which may have a direct impact on our market share and ability to grow profitably. We maintain close relationships with brokers through the business development staff, who provide training and guidance to enhance the brokers’ understanding and marketing of our products. Strong competition exists among insurers for brokers with proven ability to develop and deliver a profitable book of business. Premium volume and profitability could be negatively affected if there is a material decrease in the number of brokers that choose to sell our insurance products. We periodically issue commercial loans to or participate in equity investments in certain profitable brokers to maintain broker loyalty. By doing so we could be exposed to financial risk and potential relationship issues. To mitigate these risks, commercial loans and equity investments in brokers are subject to annual financial reviews and are supported by standard agreement terms for oversight and security assignment. The Board of Directors provides supervision by reviewing the loan portfolio and equity holdings semi-annually.

In recognition of ongoing industry growth in the direct distribution channel, we have announced plans to implement a multi-channel distribution strategy. While our broker business will continue to be a core part of our business model, we are launching a separately-branded direct channel offering to allow us to serve this distinct market segment. Given the new nature of this distribution channel for us, there is risk that we may experience unforeseen operational issues, that the implementation of the direct distribution channel may not yield the benefits expected, or that it could result in negative reputational impact. Despite working closely with our brokers, and offering the direct insurance products through a separately-branded entity, implementing the direct distribution channel may adversely impact our market share with the brokers who distribute our products. We will closely monitor the performance of the direct distribution channel and the broker network.

Financial strength rating downgrade risk

A.M. Best, an independent third-party rating agency, has provided an opinion regarding our financial strength and ability to meet ongoing insurance policy and contract obligations (“financial strength rating”). The rating agency periodically assesses our business to determine our rating, which is intended to provide an independent view of the financial strength of a financial institution, and may not uphold our financial strength rating. A downgrade in the financial strength rating could result in a loss of business, particularly in our commercial lines business, where certain customers may require that we maintain minimum ratings to enter into or renew business with us.

Demutualization risk

We are currently participating in the demutualization process in accordance with regulations published by the federal government.

The process of demutualization is expected to take more than two years and is complex. A number of events could cause the demutualization process to terminate prior to its completion, including our Board of Directors passing a resolution terminating the demutualization, any one of the necessary special resolutions not being passed by at least two-thirds of the policyholders voting at a special meeting, or the conversion proposal not being submitted to OSFI for review within one year following the appointment of the policyholder committee members by the Court. As well, the demutualization is subject to regulatory and government approval. As a result, the success, timing and outcome of the demutualization process are uncertain.

Operational and other related risks

Liquidity risk

Liquidity risk is the risk of having insufficient cash resources to meet current financial obligations, particularly those related to claim payments. Liquidity risk arises from the Company’s general business activities and in the course of managing its assets and liabilities.



The liquidity requirements of the Company’s business are met primarily by funds generated by operations, asset maturities and investment returns. To mitigate this risk, an appropriate portion of invested assets is maintained in short-term (less than one year) highly liquid money market securities, which are used to satisfy our operational requirements. A large portion of invested assets are held in highly liquid federal and provincial government debt to protect against any unanticipated large cash requirements. We have no outstanding debt aside from bank overdraft operating lines and trade payables.

Operational risk

Operational risk is the risk of financial loss from inadequate or failed processes, people and systems, or due to external events. This may relate to any of our activities and includes, for example, prohibited employee actions, criminal activity and technology failures. We manage operational risk through our three line of defence risk governance model (refer to ‘Accountability’ above for more detail), and are continually enhancing our enterprise risk management framework to include current risk assessments for all significant business and functional areas. There is also ongoing monitoring and follow-up on risks, incidents and associated controls through regular reporting by the Management Risk Committee, under the stewardship of our Chief Risk Officer, to the Risk Review Committee and other relevant Board of Directors’ committees. Internal audit creates an annual risk-based internal audit plan which takes into consideration the key inherent risks of our operations. The annual internal audit plan is approved by the Audit Committee of the Board of Directors.

Information management risk

Information management risk is the risk of loss or harm resulting from the failure to appropriately manage information during its lifecycle. We routinely collect, process, use, retain and dispose of various types of information from numerous sources, including personal information, policyholder information, and business or internal proprietary information. An inadvertent disclosure, unauthorized access or other misuse of such information could have a negative impact on the privacy of our policyholders, the continuity of our operations, or the confidentiality of our strategic plans and competitive initiatives. Although we proactively manage information management risk through our three line of defence risk governance model and enterprise risk management framework, the occurrence of such an event could result in reputational damage, financial loss, and legal and regulatory consequences.

Information technology risk

Our business depends on the successful and uninterrupted functioning of our computer and data processing systems. We rely on third-party service providers for delivering key components of these systems, including telephony, information technology infrastructure and data centre services. The failure of these systems, including failure of our third-party service providers to deliver these services, could interrupt our operations or materially impact our ability to rapidly evaluate and commit to new business opportunities or otherwise conduct business. If sustained or repeated, a system failure could result in the loss of existing or potential business relationships, compromise our ability to process transactions in a timely manner, or otherwise impair our ability to develop, modify or execute our strategies and, ultimately, could negatively affect our financial results. To manage this risk, we have an incident response process to identify, triage and respond to critical technology incidents. In addition, our data centre is managed by a reputable third-party, who provides disaster recovery services, including annual testing of, and redundant systems and facilities for, our critical services. We also require our third-party service providers to enter into service level agreements in order to secure their minimum commitment to our expected levels of service.

Cyber security risk

Cyber security risk is the risk of breach of information, loss of system integrity or availability as a result of an attack delivered via the Internet. There is an increasing prevalence of cyber-attacks affecting a variety of businesses with ever increasing operational and reputational impact. We continuously enhance systems, networks, processes and data protection measures to detect and to reduce the risk of unauthorized access, increase system resilience and minimize the impact of a cyber-attack if it were to occur.

Regulatory environment risk

Regulatory environment risk refers to the risk that modifications to regulations, including increasing complexity and amount, will threaten our ability and capacity to conduct profitable business in the future in the manner we do today.

As a participant in the P&C insurance industry, we are subject to significant regulation by the federal and provincial governments. Insurance legislation delegates regulatory, supervisory and administrative powers to federal, provincial or other jurisdictional insurance commissioners and agencies. Such regulation is generally designed to protect policyholders and is related to matters including: rate setting; restrictions on types of investments; the maintenance of adequate provisions for unearned premiums and unpaid claims; the examination of insurance companies by regulatory authorities, including periodic market conduct examinations; and the licensing of insurers and their agents and brokers. In particular, the personal automobile insurance product is subject to significant regulation in each province and it is possible that future regulatory changes may prevent us from taking actions, such as raising rates, to affect operating results.

Changes to capital and solvency standards, restrictions on certain types of investments and periodic market conduct and financial examinations by regulators could also impact our ability to successfully implement our strategy. We are required by federal regulators to maintain sufficient capital in order to ensure our continued solvency and protect us and our policyholders from adverse events. The primary solvency test we must comply with is the MCT, whereby we are required to hold at least 150% available capital against required risk-weighted capital. The internal MCT target established in our capital management policy is higher and more stringent than the regulatory minimum, and our current MCT is significantly higher. Moreover, as of January 1, 2015, federal regulators revised the MCT guidelines in order to create a more robust risk-based capital framework for P&C insurers. These changes are being phased in over three years, and we believe their cumulative impact to our regulatory ratio will be positive.



The application of existing laws or regulatory policy may require a degree of interpretation, particularly with respect to new or emerging issues. In addition, changes to laws and regulations, including changes in their interpretation or implementation or the introduction of new laws and regulations, could affect us by limiting the products or services we can provide, restricting the prices we are able to charge, requiring specified claims payments, limiting the effectiveness of our policy wordings and/or increasing the ability of competitors to compete with our products and services. Any failure by us to comply with applicable laws could result in the imposition of significant restrictions on our ability to do business, and could also result in fines and other sanctions, any or all of which could adversely affect our results of operations or financial condition. The brokers on whom we rely to distribute our insurance products are also subject to laws and regulations governing the conduct of their businesses and the disclosure they provide to policyholders. We are unable to control the extent to which those brokers comply with applicable laws and regulations, and any failure by them to do so could result in the imposition of significant restrictions on their ability to do business with us which could, in turn, adversely affect our results of operations or financial condition.

To manage regulatory risk, we have established procedures and controls through three lines of defence. Our regulatory compliance management program provides reasonable assurance that we are in compliance with applicable laws, rules and regulations. There is also ongoing monitoring and follow-up on risks, incidents and associated controls through regular reporting by the Management Risk Committee, under the stewardship of our Chief Risk Officer, who also fulfills the role of Chief Compliance Officer, to the Risk Review Committee and other relevant Board of Directors’ committees. We also actively participate in discussions with regulators and governments, and in industry groups to ensure that significant concerns are understood.

Legal and regulatory action risk

Legal and regulatory action risk refers to the impact of court awards, settlements, penalties, fines, and restrictions on the ability to carry on business as a result of lawsuits or non-compliance with regulatory requirements.

In the normal course of our business, we may from time to time be subject to a variety of legal and regulatory actions relating to our current and past business operations. In addition, plaintiffs continue to bring new types of legal claims against insurance and related companies. Current and future court decisions and legislative activity may increase our exposure to these types of claims. This risk of potential liability may make reasonable resolution of claims more difficult to obtain. We cannot determine with any certainty what new theories of recovery may evolve or what their impact may be on our businesses.

Reputational risk

Reputational risk is the risk that negative publicity regarding the P&C insurance industry generally or our conduct or business practices, whether true or not, will adversely affect our performance, operations, broker relationships or customer base, or require costly litigation or other defensive measures.

Reputational risk assessments involve a broad array of factors, including the extent and outcome of relevant legal and regulatory due diligence, the economic intent of particular transactions, the impact of events on the Company, the need for customer or public disclosure, conflicts of interest, fairness issues and public perception.

We manage reputational risk by the implementation of our code of business conduct, governance practices, enterprise risk management programs, policies, procedures and employee and broker partner training. All our directors, officers, employees and key business partners have a responsibility to conduct their activities in accordance with our code of business conduct.

Under our ethics reporting program, employees are able to contact an independent service provider on a confidential and anonymous basis to communicate any concerns regarding compliance with our code of business conduct, including questionable accounting or auditing matters, internal controls over financial reporting and our disclosure controls and procedures. All concerns raised are forwarded to designated independent Company individuals for investigation and follow-up.

Business interruption risk

Business interruption risk is associated with events that impact, or have the potential to impact, our ability to conduct business as normal. Interruptions to business can be triggered by events affecting our facilities, technology, people or third-party suppliers; including events such as floods, earthquakes, technology failures, pandemics, etc. Such events can result in losses of financial assets, property and equipment, key employees and/or the inability to write business and process transactions.

To mitigate business interruption risk, we have established a specialized Enterprise Business Continuity Management (“EBCM”) function headed by the Chief Risk Officer. The EBCM function proactively assesses potential risks to the Company, and ensures resilient planning and continuity arrangements are in place. Resiliency plans are developed and tested to ensure critical functions can continue despite a disruptive event. For example, resiliency plans exist to support emergency response, incident management, crisis management, crisis communication, disaster recovery, facilities recovery, regional incident response, business continuity, and a pandemic. We have deployed a response structure that provides rapid response to events, and have created teams at all levels to ensure quick effective decisions can be made at the appropriate level and executed efficiently. In addition, we also carry business interruption insurance to mitigate exposure to significant losses arising from business interruption events.



SECTION 13 — NON-GAAP FINANCIAL MEASURES

We measure and evaluate performance of our operations using a number of financial measures, which include assessing performance against non-GAAP measures. These non-GAAP financial measures do not have any standardized meaning prescribed by GAAP and therefore may not be comparable to similar measures presented by other companies. These non-GAAP financial measures are derived from elements of our audited consolidated financial statements, and are consistent with financial measures used in the P&C insurance industry.

These measurements are generally used in the industry and facilitate management’s comparisons to our historical operating results and to competitors’ operating results. They also provide users with greater transparency of supplemental information used by management in assessing results and in its operational decision-making. The following non-GAAP measures are used by management in assessing our performance. These non-GAAP measures are outlined and defined below.

Claims ratio Claims and adjustment expenses (excluding the impact of discounting) during a defined period expressed as a percentage of net premiums earned for the same period.

Combined ratio Claims and adjustment expenses (excluding the impact of discounting), commissions, operating expenses (net of other underwriting revenues) and premium taxes during a defined period expressed as a percentage of net premiums earned for the same period.

Expense ratio Underwriting expenses including commissions, operating expenses (net of other underwriting revenues) and premium taxes during a defined period, expressed as a percentage of net premiums earned for the same period.

Gross written premiums (GWP) The total premiums from the sale of insurance during a specified period.

Minimum capital test (MCT) A regulatory formula defined by the Office of the Superintendent of Financial Institutions, that is a risk-based test of capital available relative to capital required.

Net premiums written (NPW) GWP less the cost of reinsurance coverage.

Net risk ratio (NRR) The level of risk relative to capital employed by us, expressing net written premiums for a 12-month period as a ratio to total equity.

Policies in force (PIF) The number of insurance policies for which we are at risk at a specified date.

Return on equity (ROE) Net income after tax for the 12 months ended at a specified date divided by the average retained earnings over the same 12-month period.

Underwriting income Net premiums earned for a defined period less the sum of claims and adjustment expenses (excluding the impact of discounting), net commissions, operating expenses (net of other underwriting revenues) and premium taxes during the same period.



SECTION 14 — DEFINITIONS

Refer to Section 13 — ‘Non-GAAP financial measures’ for definitions of non-GAAP measures used by us to measure and evaluate performance of our operations

Catastrophe loss Generally, an event causing greater than 100 claims and gross losses in excess of $2 million.

Discounting To reflect the time value of money, the expected future payments of claim liabilities are discounted back to present value using the market yield rate of the investments used to support those liabilities. Provisions for adverse deviation are also included when determining the discounted value.

Claims development The difference between prior year end estimates of ultimate undiscounted claim costs and the current estimates for the same block of claims. A favourable development represents a reduction in the estimated ultimate claim costs during the period for that block of claims.

Frequency A measure of how often a claim is reported as a function of PIF.

Fronting The use of a licensed insurer to issue an insurance policy on behalf of a self-insured organization without transferring any of the risk to the licensed insurer.

Incurred but not reported (IBNR) The amount that is added to case reserves to establish the total claim liabilities. It is intended to cover future development on reported claims as well as claims that have occurred but not yet been reported to the Company.

Large loss A gross loss in excess of $1 million.

Net premiums earned The portion of NPW equal to the expired period of time an insurance policy is in effect.

Provision for adverse deviation (PfAD)

An amount that is added to the discounted claims and adjustment expenses to reduce the potential adverse effect of the uncertainty that is inherent in the assumptions and data used to estimate such liabilities.

Severity A measure of the average dollar amount paid per claim.

Total equity Retained earnings plus accumulated other comprehensive income.


CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS


Consolidated Balance Sheet 51

Consolidated Statement of Comprehensive Income 52

Consolidated Statement of Changes in Equity 53

Consolidated Statement of Cash Flows 54

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Nature of Operations 55

Note 2 – Summary of Significant Accounting Policies 55

Note 3 – Standards Issued But Not Yet Effective 62

Note 4 – Significant Accounting Judgments, Estimates and Assumptions 62

Note 5 – Investments 63

Note 6 – Nature and Extent of Risks Arising From Financial Instruments 67

Note 7 – Policy Liabilities 70

Note 8 – Nature and Extent of Risks Arising From Insurance Contracts 73

Note 9 – Reinsurance Contracts 77

Note 10 – Property and Equipment 78

Note 11 – Income Taxes 79

Note 12 – Goodwill and Intangible Assets 80

Note 13 – Other Assets 82

Note 14 – Investments in Associates 82

Note 15 – Accounts Payable and Other Liabilities 83

Note 16 – Premiums 83

Note 17 – Post-Employment Benefits 83

Note 18 – Capital Management 87

Note 19 – Rate Regulation 87

Note 20 – Commitments and Contingencies 88

Note 21 – Demutualization 88

Note 22 – Supplemental Expense Information 88

Note 23 – Related Party Transactions 89

Note 24 – Medium-Term Incentive Plan 90

Note 25 – Operating Segments 91



REPORT OF MANAGEMENT’S ACCOUNTABILITY

The accompanying consolidated financial statements have been prepared by management in accordance with International Financial Reporting Standards and have been approved by the Board of Directors.

Management is responsible for ensuring that these consolidated financial statements, which include amounts based on estimates and judgments, are consistent with other information and operating data contained in the Annual Report, and fairly reflect the Company’s business transactions and financial position, in all material respects.

The integrity and reliability of Economical Mutual Insurance Company’s reporting systems are achieved through the use of formal policies and procedures, the careful selection of employees and appropriate delegation of authority and division of responsibilities. The responsibility of the internal auditor is to monitor and assess the integrity of the internal controls within key business processes. Economical’s Code of Business Conduct, which is communicated to all levels in the organization, requires employees to maintain high standards in their conduct of the Company’s affairs.

The external auditor, Ernst & Young LLP, whose report on their audit of the consolidated financial statements follows, also reviews the Company’s systems of internal accounting control in accordance with Canadian generally accepted auditing standards for the purpose of expressing their opinion on the consolidated financial statements.

The appointed actuary is appointed by the Board of Directors pursuant to the Insurance Companies Act (Canada). The appointed actuary is responsible for ensuring that the assumptions and methods used in the valuation of policy liabilities are in accordance with accepted actuarial practice, and applicable legislation and associated regulations or directives. The appointed actuary is also required to provide an opinion regarding the appropriateness of the policy liabilities at the balance sheet date to meet all policyholder obligations of the Company. Examination of supporting data for accuracy and completeness is an important element of the work required to form this opinion.

The Board of Directors annually appoints an Audit Committee comprising of directors who are not employees of the Company. This committee meets regularly with management, the internal auditor and the external auditor to review significant accounting, reporting and internal control matters. Both the internal and external auditors and the appointed actuary have unrestricted access to the Audit Committee. Following its review of the consolidated financial statements and the report of the external auditor, the Audit Committee submits its report to the Board of Directors for formal approval of the consolidated financial statements.

KAREN GAVAN President and Chief Executive Officer

PHILIP MATHER Senior Vice President and Chief Financial Officer

Waterloo, Canada February 19, 2016

| 48 2015 ANNUAL REPORT


APPOINTED ACTUARY’S REPORT

To the Members of Economical Mutual Insurance Company:

I have valued the policy liabilities and reinsurance recoverables of Economical Mutual Insurance Company for its consolidated balance sheet at December 31, 2015 and their changes in the consolidated statement of comprehensive income for the year then ended in accordance with accepted actuarial practice 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 policy obligations and the consolidated financial statements fairly present the results of the valuation.

LINDA M. GOSS Fellow, Canadian Institute of Actuaries

Waterloo, Canada February 19, 2016



INDEPENDENT AUDITORS’ REPORT To the Members of

Economical Mutual Insurance Company

We have audited the accompanying consolidated financial statements of Economical Mutual Insurance Company, which comprise the consolidated balance sheet as at December 31, 2015 and the consolidated statements of comprehensive income, changes in equity and cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information.

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, 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 audit. We conducted our audit in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies 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 is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Economical Mutual Insurance Company as at December 31, 2015 and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards.

Chartered Professional Accountants Licensed Public Accountants

Kitchener, Canada February 19, 2016



CONSOLIDATED BALANCE SHEET AS AT DECEMBER 31 (in thousands of dollars) Notes 2015 2014

ASSETS

Cash and cash equivalents $ 89,010 $ 89,152

Investments 5 4,064,932 4,061,397

Accrued investment income 15,892 14,398

Premiums receivable 601,161 581,712

Income taxes receivable 16,098 -

Reinsurance receivable and recoverable 7,9 81,708 100,025

Deferred policy acquisition expenses 7 207,837 202,780

Property and equipment 10 38,632 32,540

Deferred income tax assets 11 41,082 42,925

Goodwill and intangible assets 12 131,575 61,892

Other assets 13 57,129 42,000

$ 5,345,056 $ 5,228,821

LIABILITIES AND EQUITY

Unearned premiums 7 $ 1,022,339 $ 995,486

Claim liabilities 7,8 2,309,265 2,361,208

Accounts payable and other liabilities 15 234,467 190,682

Income taxes payable - 311

3,566,071 3,547,687

EQUITY

Retained earnings 1,762,205 1,581,814

Accumulated other comprehensive income 16,780 99,320

Total equity 18 1,778,985 1,681,134

$ 5,345,056 $ 5,228,821

Commitments and contingencies 20

See accompanying notes.

On behalf of the Board:

J.H. Bowey Director

K.L. Gavan Director



CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

FOR THE YEAR ENDED DECEMBER 31 (in thousands of dollars) Notes 2015 2014

Gross premiums written 16 $ 2,008,387 $ 1,963,043

Net premiums written 16 $ 1,935,352 $ 1,877,801

Net premiums earned 16 $ 1,905,655 $ 1,845,282

Other underwriting revenues 26,659 25,557

Total underwriting revenues 1,932,314 1,870,839

Underwriting expenses:

Net claims and adjustment expenses, undiscounted 7,9,22 1,221,450 1,281,203

Net commissions 9 363,688 356,919

Operating expenses 22 231,638 206,099

Premium taxes 66,715 64,984

1,883,491 1,909,205

Underwriting income (loss) before the impact of discounting 48,823 (38,366)

Impact of discounting 7 (1,488) (16,071)

Underwriting income (loss) 47,335 (54,437)

Investment income:

Interest 5 67,644 76,661

Dividends 5 37,926 29,515

Recognized gains on investments 5 73,881 58,065

179,451 164,241

Other income (expense) 17, 21 2,928 (3,582)

Restructuring expenses - (1,289)

Income before income taxes 229,714 104,933

Income tax expense 11 53,760 20,742

Net income $ 175,954 $ 84,191

Items that may be reclassified subsequently to net income:

Net unrealized (losses) gains on AFS investments (72,053) 81,613

Reclassification to net income of net recognized gains on AFS investments 5 (46,142) (30,176)

Foreign exchange gain on investments in subsidiaries 3,890 1,475

Income tax (recovery) expense 11 (31,765) 13,486

(82,540) 39,426

Items that will not be reclassified subsequently to net income:

Post-employment benefit obligation gain (loss) 17 6,055 (21,206)

Income tax expense (recovery) 11 1,618 (5,607)

4,437 (15,599)

Other comprehensive (loss) income (78,103) 23,827

Comprehensive income $ 97,851 $ 108,018




CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

FOR THE YEAR ENDED DECEMBER 31 (in thousands of dollars)

2015 2014

Retained earnings

Accumulated other comprehensive

income Total

equity Retained earnings

Accumulated other comprehensive

income Total equity

Balance, beginning of the year $ 1,581,814 $ 99,320 $ 1,681,134 $ 1,513,222 $ 59,894 $ 1,573,116

Net income 175,954 - 175,954 84,191 - 84,191

Other comprehensive (loss) income 4,4371 (82,540) (78,103) (15,599)1 39,426 23,827

Total comprehensive income 180,391 (82,540) 97,851 68,592 39,426 108,018

Balance, end of the year $ 1,762,205 $ 16,7802 $ 1,778,985 $ 1,581,814 $ 99,3202 $ 1,681,134

1 Actuarial gains (losses) for the defined benefit plan recognized in retained earnings (net of income tax expense of $1,618 (2014: $5,607 income tax recovery)). 2 Included in accumulated other comprehensive income is $5,868 (2014: $1,978) related to the cumulative foreign exchange gain on investments in associates.




CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31 (in thousands of dollars) Notes 2015 2014

Operating activities:

Receipts:

Premiums collected $ 1,915,634 $ 1,846,871

Interest received 87,193 88,240

Dividends received 37,287 29,365

2,040,114 1,964,476

Payments:

Claims paid 7 1,261,972 1,226,452

Commissions and expenses paid 553,307 531,226

Premium taxes paid 66,166 65,119

Income taxes paid 38,012 691

Restructuring expenses paid 1,445 8,876

1,920,902 1,832,364

Net cash provided by operating activities 119,212 132,112

Investing activities:

Investments purchased (3,392,190) (2,335,384)

Investments sold, redeemed or matured 3,311,866 2,216,739

Commercial loans advanced (5,517) (3,006)

Commercial loans repaid 13,118 9,894

Other assets purchased (45,331) (18,446)

Business acquisitions (1,300) -

Net cash used in investing activities (119,354) (130,203)

Cash and cash equivalents:

Net (decrease) increase during the year (142) 1,909

Balance, beginning of the year 89,152 87,243

Balance, end of the year $ 89,010 $ 89,152

Cash $ 89,010 $ 80,738

Cash equivalents - 8,414

Total cash and cash equivalents $ 89,010 $ 89,152




NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF OPERATIONS

Economical Mutual Insurance Company (the “Company”) is a mutual insurance company which, along with its wholly owned subsidiaries, offers property and casualty (“P&C”) insurance primarily in Canada. The Company is incorporated and domiciled in Canada. Its registered office and principal place of business is 111 Westmount Road South, Waterloo, Ontario, Canada.

These consolidated financial statements were approved by the Company’s Board of Directors on February 19, 2016.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of preparation

These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) and Canadian accepted actuarial practice and reflect the requirements of the Office of the Superintendent of Financial Institutions Canada (“OSFI”).

These consolidated financial statements have been prepared on a historical cost basis, except for those financial instruments that have been measured at fair value and claim liabilities which are valued on a discounted basis in accordance with accepted actuarial practice.

The financial statements of the subsidiaries and material associates are prepared for the same reporting period as the Company. Where necessary, adjustments are made to bring the accounting policies of subsidiaries and associates in line with the Company. The consolidated financial statements include the accounts of Economical Mutual Insurance Company and its wholly owned subsidiaries. Each of the subsidiaries operate and are incorporated in Canada.

The Company’s non-controlling interest investments in companies subject to significant influence are accounted for using the equity method and are included in “Other assets”. Under the equity method, the original cost of the investments is increased by the comprehensive income of the non-controlling interest since acquisition and reduced by any dividends received. All significant inter-company transactions and balances have been eliminated on consolidation to the extent of the interest in the associate.

All amounts in the notes are shown in thousands of Canadian dollars, unless otherwise stated.

(b) Insurance contracts

Insurance contracts are those contracts which transfer significant insurance risk at inception. The Company (the insurer) has accepted significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified event (the insured event) with uncertain timing or amount adversely affects the policyholder. Similarly, by purchasing reinsurance, the Company transfers significant insurance risk to the reinsurers. As a general guideline, the Company determines whether significant insurance risk has been transferred for insurance and reinsurance contracts by comparing whether significantly more would be paid or received if the insured event occurs, versus if the insured event did not occur.

Once a contract has been classified as an insurance contract, it remains an insurance contract for the remainder of its lifetime, even if the insurance risk reduces significantly during this period, unless all rights and obligations are extinguished or expire.

Premiums and unearned premiums

Premiums are recognized in net income in the consolidated statement of comprehensive income on a pro-rata basis over the contract period. Premiums on policies written with monthly payment terms are accounted for in full in the year written. Premiums receivable include the premiums due for the remaining months of the contracts. Written premiums on multi-year policies are recognized in gross written premiums in the year written and are recognized in net income on a pro-rata basis over the contract period. Unearned premiums (“UPR”) represent the portion of premiums written relating to periods of insurance coverage subsequent to the reporting date and are presented as a liability gross of amounts ceded to reinsurers. UPR ceded to reinsurers is included in “Reinsurance receivable and recoverable”.

Claim liabilities

Claim liabilities are calculated based on Canadian accepted actuarial practice. The claim liabilities consist of reserves for reported claims as determined on a case-by-case basis by claims adjusters and an actuarially determined provision for incurred but not reported claims (“IBNR”). The estimates include related investigation, settlement and adjustment expenses. Measurement uncertainty in these estimates exists due to internal and external factors that can substantially impact the ultimate settlement costs. Consequently, the Company reviews and re-evaluates claims and reserves on a regular basis and any resulting adjustments are included in “Net claims and adjustment expenses” in the consolidated statement of comprehensive income in the period the adjustment is made. Claims and adjustment expenses are reported net of reinsurance. The claim liabilities are valued on a discounted basis using a rate that is derived from the fair value yield of the bonds that have been identified as supporting the claim liabilities and adding in a provision for adverse deviation (“PfAD”). The effect of discounting plus PfAD is included in “Impact of discounting” in the consolidated statement of comprehensive income. The claim liabilities are extinguished when the obligation to pay a claim expires, is discharged or is cancelled.



2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

(b) Insurance contracts (continued)

Deferred policy acquisition expenses

The amount of deferred policy acquisition expenses (“DPAE”) represents the brokers’ commission and premium taxes associated with the unearned portion of the premiums written during the year to the extent they are considered recoverable. The costs are expensed in the year in which the related premiums are recognized as income. To the extent deferred commissions and premium taxes are considered non-recoverable, they are expensed as incurred in the consolidated statement of comprehensive income. The maximum deferrable amount is calculated through the liability adequacy test.

Liability adequacy test

Quarterly, an assessment is made of whether the policy liabilities are adequate, which includes both claim liabilities and premium liabilities. Claim liabilities are assessed using current estimates of future cash flows of unpaid claims and adjustment expenses, discounted to reflect the time value of money. If that assessment shows that the carrying amount of the claim liabilities is insufficient in light of the current future cash flows, the deficiency is recognized in the consolidated statement of comprehensive income. Premium liabilities are assessed using current estimates of the discounted future claims and expenses associated with the unexpired portion of written insurance policies. A premium deficiency would be recognized immediately as a reduction of DPAE to the extent that the unearned premiums are not considered adequate to cover DPAE and premium liabilities. If the premium deficiency is greater than DPAE, a liability is accrued for the excess deficiency.

Industry pools

When certain automobile owners are unable to obtain insurance via the voluntary insurance market, they are insured by the Facility Association (“FA”). In addition, entities can choose to cede certain risks to industry administered risk sharing pools (“RSP”) or in Quebec, the Plan de Repartition des Risques (“PRR”) (collectively “the pools”). The related risks associated with FA insurance policies and policies ceded by companies to the pools are aggregated and shared by the entities in the P&C insurance industry, generally in proportion to market share and volume of business ceded to the pools. The Company applies the same accounting policies to FA and pool insurance it assumes as it does to insurance policies issued by the Company directly to policyholders and thus the Company’s share of pool premiums and claims is included in the relevant financial statement line items. The Company’s share of the pool assets backing policy liabilities is included in “Reinsurance receivable and recoverable”.

Reinsurance

Reinsurance receivable and recoverable includes reinsurers’ share of UPR and claim liabilities. The Company presents third party reinsurance balances in the consolidated balance sheet on a gross basis to indicate the extent of credit risk related to third party reinsurance and its obligations to policyholders. The estimates for the reinsurers’ share of claim liabilities are determined on a basis consistent with the related claim liabilities. Reinsurance assets are reviewed at least quarterly for impairment.

Structured settlements

In the normal course of claims settlement, the Company enters into annuity agreements with various Canadian life insurance companies, that are required to have credit ratings of at least “A-” or higher, to provide for fixed and recurring payments to claimants in full satisfaction of the claim liability. Under such arrangements, the Company removes the liability from its consolidated balance sheet when the liability to its claimants is substantially discharged and legal release has also been obtained from the claimant, although the Company remains exposed to the credit risk that life insurers will fail to fulfill their obligations. See note 6 for further discussion of credit risk.

(c) Cash and cash equivalents

Cash and cash equivalents consist of cash on hand, balances on deposit with banks and term deposits having original maturities of ninety days or less. Fair values approximate carrying values for term deposits. The amount of cash not readily available for use by the Company is insignificant.

(d) Financial instruments including investments

All of the Company’s financial instruments are classified into one of the following four categories as defined below:

• available for sale (“AFS”)

• financial assets and liabilities at fair value through profit or loss (“FVTPL”)

• loans and receivables

• other financial liabilities

All financial instruments are initially recognized at fair value and are subsequently accounted for based on their classification as described below. The classification depends on the purpose for which the financial instruments were acquired and their characteristics. Instruments voluntarily designated as FVTPL to support the claim liabilities may never be reclassified and, except in very limited circumstances, the reclassification of other financial instruments is not permitted subsequent to initial recognition. Financial assets purchased and sold, where the contract requires the asset to be delivered within an established timeframe, are recognized on a settlement-date basis. Transaction costs are expensed as incurred for FVTPL financial instruments. For other financial instruments, transaction costs are capitalized on initial recognition. The effective interest rate method of amortization is used to account for any transaction costs capitalized on initial recognition and purchased premiums or discounts earned on bonds.




(d) Financial instruments including investments (continued)

The fair value of a financial instrument on initial recognition is normally the transaction price, i.e. the fair value of the consideration given. Subsequent to initial recognition, the fair values are determined based on available information. The fair values of investments, excluding commercial loans, are based on quoted bid market prices where available or observable market inputs. The fair values of commercial loans and other financial instruments are obtained using discounted cash flow analysis at the current market interest rate for comparable financial instruments with similar terms and risks.

Financial instruments are no longer recognized when the rights to receive cash flows from the investments have expired or have been transferred and the Company has transferred substantially all the risks and rewards of ownership.

Available for sale

All short-term investments, equities (including preferred stocks, common stocks and pooled funds) and bonds, except those voluntarily designated as FVTPL, are designated as AFS. Short-term investments consist of term deposits having original maturities of greater than ninety days and less than one year. AFS financial instruments are carried at fair value. Changes in fair value are recorded, net of income taxes, in “Other comprehensive (loss) income” (“OCI”) in the consolidated statement of comprehensive income until the disposal of the financial instrument, or when an impairment loss is recognized. When the financial instrument is disposed of, the gain or loss is reclassified from “Accumulated other comprehensive income” (“AOCI”) to “Recognized gains on investments” in the consolidated statement of comprehensive income. Gains and losses on the sale of AFS financial instruments are calculated on an average cost basis.

The Company assesses its AFS financial instruments for objective evidence of impairment quarterly. Objective evidence of impairment exists for individual equities (including common stocks and pooled funds) when there has been a significant or prolonged decline in fair value or net asset value below cost. Objective evidence of impairment exists for individual bonds when a loss event that has a reliably estimable impact on the future cash flows of the financial instrument has occurred. Factors that are considered include, but are not limited to, a decline in current financial position, defaults on debt obligations, failure to meet debt covenants, significant downgrades in credit status, and severity and/or duration of the decline in value. For individual preferred stocks, the key features of the preferred stock are assessed to determine if the instrument is more characteristic of an equity instrument or a debt instrument and objective evidence of impairment is evaluated accordingly. Preferred stock that are redeemable at the Company’s option, and perpetual preferred stock purchased to produce dividend income for the long-term, are assessed using the same methodology as the bond impairment analysis.

When objective evidence of impairment exists for a financial instrument, the impairment loss is measured as the difference between carrying value and fair value. Impairment losses on AFS financial instruments are reclassified from AOCI to “Recognized gains on investments” in the consolidated statement of comprehensive income in the period such criteria are met. Subsequent fair value increases on previously impaired individual equities and pooled funds are recognized directly in OCI and not reversed through net income, while subsequent fair value decreases are recognized directly in net income. For individual bonds or preferred stocks, subsequent fair value increases that can be attributed to an observable positive development are recognized directly in net income, but otherwise, are recognized directly in OCI. Any subsequent reversal of an impairment loss on a bond or preferred stock is recognized in net income, to the extent that the carrying value of the asset does not exceed its amortized cost at the reversal date.

Fair value through profit or loss

The Company has voluntarily designated a portion of its bonds as FVTPL. The Company has no other significant FVTPL financial assets. Changes in fair values as well as gains and losses on disposal of FVTPL financial instruments are recorded in “Recognized gains on investments” in the consolidated statement of comprehensive income with the related tax impact included in “Income tax expense”. Gains and losses on the sale of FVTPL financial instruments are calculated on an average cost basis. Changes in the fair value of the FVTPL financial instruments are reflected within net income in the consolidated statement of comprehensive income, so it is not necessary to record an impairment loss when there has been a significant or prolonged decline in the fair value of FVTPL financial instruments.

The designation of the FVTPL bond portfolio aims to reduce the accounting mismatch in net income that would otherwise be generated by the fluctuations in fair values of underlying claim liabilities due to changes in interest rates. In compliance with OSFI guidelines, the Company manages the FVTPL portfolio’s quantum and duration so that the impact of changes in interest rates on claim liabilities and the FVTPL portfolio reasonably offset each other.

Loans and receivables/Other financial liabilities

Financial instruments classified as loans and receivables, including commercial loans, and other financial liabilities are initially recognized at fair value and subsequently measured at amortized cost using the effective interest rate method. When there is evidence of impairment, the value of these financial instruments is written down to the estimated net realizable value through “Recognized gains on investments” in the consolidated statement of comprehensive income.

Evidence of impairment exists for individual commercial loans when there is a deterioration in financial performance to the extent that the Company no longer has reasonable assurance of timely collection of the full amount of principal and interest.

Investment income recognition

Interest income is recognized on bonds and commercial loans on the accrual basis and includes the amortization of premiums and discounts over the life of the investment using the effective interest rate method. The treatment of recognized gains and losses on disposal of AFS and FVTPL investments is discussed in “Available for sale” and “Fair value through profit or loss” above.

Dividend income is recognized on the ex-dividend date.




(e) Property and equipment

Property and equipment are recorded at historical cost less accumulated depreciation and accumulated impairment losses, if any.

Cost includes amounts directly attributable to the acquisition of the items of property and equipment. Subsequent costs are added to the cost of the asset only when it is probable that economic benefits will flow to the Company in the future and the cost can be reliably measured.

Depreciation is recorded on a straight-line or declining balance basis to write down the cost of such assets to their residual value over their expected useful lives. Each component of property and equipment with a cost that is significant in relation to the total cost of the asset is depreciated separately. Residual values, depreciation rates and useful lives are reviewed at least annually and adjusted, if appropriate, at the reporting date. Land is not subject to depreciation and is carried at cost.

Property and equipment are depreciated as follows:

Basis Rates

Buildings — structure Straight-line 50 years Buildings — infrastructure Straight-line 25 years Buildings — fixtures Straight-line 15 years Computer equipment Straight-line 4 years Furniture and equipment Declining balance 20%

Property and equipment are derecognized upon disposal or when no further future economic benefits are expected from their use or disposal. Gains and losses on disposal are calculated as the difference between proceeds and net carrying value and are recognized in “Other income (expense)” in the consolidated statement of comprehensive income. Fully depreciated property and equipment are retained in cost and accumulated depreciation accounts until such assets are removed from service.

(f) Leases

Leases of property and equipment where the Company is not exposed to substantially all of the risks and rewards of ownership are classified as operating leases. Incentives received from the lessor on such leases are deferred and amortized on a straight-line basis over the term of the lease in the consolidated statement of comprehensive income. Where substantially all of the risks and rewards have been transferred to the Company, the lease is classified as a finance lease. In these cases, an obligation and an asset are recognized based on the present value of the future minimum lease payments and balances are amortized over the shorter of the lease term or useful life of the asset, as applicable.

(g) Basis of consolidation

Business combinations are accounted for using the acquisition method. The acquisition method requires that the acquirer recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree, at the acquisition date. Acquisition costs directly attributable to the acquisition are expensed in the year incurred. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured at fair value at the date of acquisition, irrespective of the extent of any non-controlling interest. Contingent consideration is also measured at fair value at the acquisition date.

The Company measures goodwill as the fair value of the consideration transferred, including the recognized amount of any non-controlling interest in the acquiree, less the net recognized amount (generally fair value) of the identifiable assets acquired and liabilities assumed, all measured as of the acquisition date. After initial recognition, goodwill is measured at cost less any accumulated impairment losses.

When the Company is exposed, or has rights, to variable returns from its involvement with an investee and has the ability to affect those returns through its power over the investee, the investee is considered a subsidiary. Subsidiaries are fully consolidated from the date that control is obtained by the Company. Subsidiaries are deconsolidated from the date that control ceases.

When the Company has significant influence over an investee, that is the power to participate in the financial and operating decisions of the investee but does not have control or joint control over those decisions, the investee is considered to be an associate. Associates are accounted for under the equity method.

(h) Intangible assets

Intangible assets include capitalized software costs, where the software is not integral to the hardware on which it operates. Intangible assets acquired separately are measured on initial recognition at cost. The cost of intangible assets acquired in a business combination is their fair value as at the date of acquisition. Costs that are directly attributable to the development and testing of identifiable and unique software products controlled by the Company are recognized as intangible assets when the criteria specified in IAS 38 — Intangible Assets (“IAS 38”) are met. Capitalized costs include employee costs for staff directly involved in software development and other direct expenditures related to the project. Other development expenditures that do not meet the capitalization criteria under IAS 38 are recognized as an expense as incurred. Following the initial recognition, intangible assets are carried at cost less accumulated amortization and accumulated impairment losses, if any.

Intangible assets with finite useful lives are amortized over their useful economic life to a maximum of seven years. Amortization is recorded in “Operating expenses” in the consolidated statement of comprehensive income. The amortization period and the amortization method for an intangible asset with a finite useful life are reviewed at least annually. Intangible assets which are under development are not amortized but are tested at least annually for impairment. The Company does not currently hold any indefinite life intangible assets.




(i) Impairment of assets

The Company assesses at each reporting date whether there is an indication that an asset may be impaired. If any such indication exists, or when annual impairment testing for an asset is required, the Company compares the asset’s recoverable amount to the asset’s carrying value. An asset’s recoverable amount is calculated based on the value-in- use (“VIU”) using a discounted cash flow model. The recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets and therefore, must be assessed as part of a cash-generating unit (“CGU”).

For assets, excluding goodwill and certain financial instruments, an assessment is made at each reporting date as to whether there is any indication that previously recognized impairment losses may no longer exist or may have decreased. If such an indication exists, the Company compares the recoverable amount to the carrying value of the asset. If the recoverable amount exceeds the carrying value of the asset, the carrying value is increased to the lesser of the recoverable amount and the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognized for the asset in prior years. Such reversal is recognized in the consolidated statement of comprehensive income.

The following criteria are also applied in assessing impairment of specific assets:

Goodwill

Goodwill is tested for impairment in accordance with IAS 36 — Impairment of Assets, which requires goodwill impairment to be assessed at a CGU level. For the purposes of impairment testing, goodwill acquired in a business combination is allocated to each of the Company’s CGUs, or groups of CGUs, that are expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the Company are assigned to those units or groups of units. The Company has defined the CGUs to be each insurance company and each broker or managing general agent subsidiary.

Goodwill relating to an associate is included in the carrying amount of the investment and is not tested separately for impairment.

The Company performs a goodwill impairment review at least annually and whenever there is an indication that goodwill is impaired. The fair value of each CGU has been determined based on the VIU using a discounted cash flow model. Impairment occurs when the carrying amount of the CGU exceeds the recoverable amount, in which case goodwill impairment is recognized prior to impairing other assets. Any impairment of goodwill or other assets is recorded in “Other income (expense)” in the year that such an impairment becomes evident. Previously recorded impairment losses for goodwill are not reversed in future years if the recoverable amount increases.

Investments in associates

After application of the equity method, the Company determines whether it is necessary to recognize an additional impairment loss of the Company’s investments in associates. The Company determines at each balance sheet date whether there is any objective evidence that the investments in associates are impaired. If this is the case, the Company calculates the amount of impairment as being the difference between the fair value of the associate and the carrying value, and recognizes this amount in the consolidated statement of comprehensive income in “Other income (expense)”.

(j) Income taxes

Income tax expense is comprised of current and deferred income tax. Income tax is recognized in net income except to the extent that it relates to items recognized in OCI or directly to retained earnings.

Current income tax is based on the results of operations in the current year, adjusted for items that are not taxable or not deductible. Current income tax is calculated based on income tax laws and rates enacted or substantively enacted as at the reporting date. Interest income or expenses arising on tax assessments are included in “Other income (expense)” in the consolidated statement of comprehensive income.

Deferred income tax is provided using the liability method on temporary differences between the tax bases of assets and liabilities and their respective carrying amounts for financial reporting purposes at the reporting date. Deferred income tax is calculated using income tax laws and rates enacted or substantively enacted as at the reporting date, which are expected to apply when the related deferred income tax asset is realized or the deferred income tax liability is settled.

The carrying amount of deferred income tax assets is reviewed at each reporting date and reduced to the extent that it is no longer probable that sufficient taxable income will be available to allow all or part of the deferred income tax asset to be utilized. Unrecognized deferred income tax assets are reassessed at each reporting date and are recognized to the extent that it has become probable that future taxable income will allow the deferred income tax asset to be recovered.

(k) Pensions, other post-employment benefits and other employee benefits

The Company provides certain pension and other post-employment benefits to eligible participants upon retirement.

Pension benefits

The Company operates a defined benefit pension plan for certain employees hired prior to January 1, 2002, which requires contributions to be made to a separately administered fund. The benefit is based on the employee’s length of service and final average pensionable earnings. The cost of the defined benefits is actuarially determined and accrued using the projected unit credit valuation method pro-rated on service. This method involves the use of the market interest rate at the measurement date on high-quality debt instruments for the discount rate, and management’s best estimates concerning such factors as salary escalation, and retirement ages of employees. Costs recognized in the consolidated statement of comprehensive income include the cost of pension




(k) Pensions, other post-employment benefits and other employee benefits (continued)

Pension benefits (continued)

benefits provided in exchange for employees’ services rendered during the year, and the net interest cost calculated by applying a discount rate to the net defined benefit obligation. Actuarial gains and losses are recognized in full in OCI in the year in which they occur and then immediately in retained earnings. They are not reclassified to net income in subsequent years. Past service costs, which are a result of a plan amendment or curtailment, are recognized in “Other income (expense)” in the consolidated statement of comprehensive income when the amendment or curtailment has occurred.

The defined benefit asset or liability comprises the fair value of plan assets less the defined benefit obligation out of which the obligations are to be settled directly. Plan assets are held by a long-term employee benefit fund and are not available to creditors of the Company, nor can they be paid directly to the Company. Fair value is based on market price information and in the case of quoted securities it is the published closing price. The value of any defined benefit asset is restricted to the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan.

The accumulated value for pension benefits is recorded in the consolidated balance sheet in “Other assets” if the balance is in an asset position and is recorded in “Accounts payable and other liabilities” if in a liability position. The Company also has a defined contribution plan for certain employees, for which company contributions are expensed in the year they are due. The Company has no further payment obligations once the company contributions and applicable administration fees have been paid.

Non-pension benefits

The Company provides other post-employment benefits for eligible employees hired prior to July 3, 2012. The Company accounts for the cost of all non-pension post-employment benefits, including medical benefits, dental care and life insurance for eligible retirees, their spouses and qualified dependents, on an accrual basis. These costs are recognized in “Operating expenses” in the consolidated statement of comprehensive income in the year during which services are rendered and are actuarially determined using the projected unit credit valuation method pro-rated on service. This method involves the use of the market interest rate at the measurement date on high-quality debt instruments for the discount rate, and management’s best estimates concerning such factors as salary escalation, retirement ages of employees and expected health care costs. The impact of a plan curtailment is recognized in “Other income (expense)” in the consolidated statement of comprehensive income when an event giving rise to a curtailment has occurred.

Actuarial gains and losses, except for long-term disability benefits, are recognized in full in OCI in the year in which they occur and then immediately in retained earnings. They are not reclassified to net income in subsequent years. Actuarial gains and losses for long-term disability benefits are recognized in “Operating expenses” in the consolidated statement of comprehensive income.

The accumulated value for non-pension post-employment benefits is recorded in the consolidated balance sheet in “Accounts payable and other liabilities”.

Termination benefits

Termination benefits are payable when employment is terminated by the Company before the normal retirement date, or whenever an employee accepts voluntary redundancy in exchange for these benefits. The Company recognizes termination benefits at the earlier of the following dates: (a) when the Company can no longer withdraw the offer of those benefits; and (b) when the Company recognizes costs for a restructuring that is within the scope of IAS 37 — Provisions, Contingent Liabilities and Contingent Assets and involves the payment of termination benefits. In the case of an offer made to encourage voluntary redundancy, the termination benefits are measured based on the number of employees expected to accept the offer. Benefits falling due more than 12 months after the end of the reporting period are discounted to their present value.

Short-term incentive plan

The Company recognizes a liability and an expense for bonuses based on a formula that takes into consideration various financial metrics. The Company recognizes a provision where contractually obliged or where there is a past practice that has created a reasonable expectation of a constructive obligation.

Medium-term incentive plan

In fiscal 2014, a Medium Term Incentive Plan (“MTIP” or “Plan”) was introduced. Under this Plan notional units (hereinafter referred to as Restricted Units or Performance Units) are granted annually to executive management based on the book value of the Company. The value of the Restricted Units (“RUs”) which comprise 40% of the units granted will fluctuate based solely on the book value of the Company. The remaining 60% of the units granted are Performance Units (“PUs”), the value of which will also fluctuate based on the Company’s three year Return on Equity (“ROE”) performance relative to a select group of the largest Canadian P&C companies (the “Peer Group”). The Peer Group includes companies with the highest gross premiums written in Canada. The RUs and PUs vest three years after the grant date and are then settled in cash. There are floor and ceiling mechanisms in place to ensure that the PUs do not pay when absolute performance is below a minimum threshold, even if performance is at a level commensurate or ahead of the Peer Group of companies and that the total Plan payout does not exceed the ceiling even in periods of significant outperformance.

The cost of the awards are recognized as an expense over the vesting period based on the estimated payout under the Plan at the end of three years, with a corresponding financial liability recorded in “Accounts payable and other liabilities”. The Company re-estimates the value of awards that are expected to vest at each reporting period. The ultimate liability for any payment of RUs and PUs is dependent on the book value of the Company at the vesting date. For PUs, the liability is also dependent on the Company’s three year ROE performance relative to the Peer Group.




(l) Provisions

Provisions, including restructuring provisions, are recognized when the Company determines that there is a present legal or constructive obligation as a result of a past event or decision, it is more likely than not that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated.

Provisions are measured at the present value of the expenditures expected to be required to settle the obligation using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the obligation.

(m) Foreign currency translation

Functional and presentation currency

The consolidated financial statements are presented in thousands of Canadian dollars, which is also the functional currency of the Company. Each entity within the consolidated group determines its own functional currency based upon the currency used in the entity’s primary operating environment, and measures financial results based on that functional currency.

Translation of foreign subsidiaries’ accounts

Assets and liabilities of the Company’s foreign subsidiaries are translated from their functional currencies into Canadian dollars at the exchange rate in effect at the reporting date for all assets and liabilities, except goodwill acquired prior to the IFRS transition date of January 1, 2010 (“transition date”).

Any goodwill arising on the acquisition of a foreign operation subsequent to the transition date and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition are treated as assets and liabilities of the foreign operation and translated at the closing rate.

Revenues and expenses are translated at the monthly weighted average rate prevailing during the year. On consolidation, exchange differences arising from the translation of the net investment in foreign entities are recorded in OCI. On the disposal of a foreign operation, the cumulative amount of exchange differences relating to that operation is recognized in net income.

Translation of foreign currency transactions

Transactions incurred in currencies other than the functional currency of the reporting entity are converted to the functional currency at the rate in effect on the transaction date. Monetary assets and liabilities denominated in a currency other than the functional currency are converted to the functional currency at the exchange rate in effect at the reporting date. Unrealized foreign currency gains and losses on AFS financial instruments have been included in OCI. All other foreign currency gains and losses have been included in net income.

(n) Comparative figures

The comparative consolidated financial statements have been reclassified from statements previously presented to conform to the presentation of the current year’s consolidated financial statements.

3. STANDARDS ISSUED BUT NOT YET EFFECTIVE

The following IFRS standards have been issued but are not yet effective. The Company is currently analyzing the impact these standards will have on its consolidated financial statements, unless otherwise stated.

(a) Financial Instruments: Classification and Measurement

In July 2014, the International Accounting Standards Board (“IASB”) issued the final version of IFRS 9 — Financial Instruments (“IFRS 9”), which reflects all phases of the financial instruments project and replaces IAS 39 — Financial Instruments: Recognition and Measurement and all previous versions of IFRS 9. IFRS 9 sets out the requirements for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. This single, principle-based approach replaces existing rule-based requirements and is intended to improve and simplify the reporting for financial instruments. IFRS 9 is effective for annual periods beginning on or after January 1, 2018. Retrospective application is required with certain exceptions.

Proposed amendments to IFRS 4 — Insurance Contracts were issued in December 2014 and have an expected effective date for years beginning on or after January 1, 2018. The amendments propose an optional temporary exemption from applying IFRS 9 that would be available to companies whose predominant activity is to issue insurance contracts. Such a proposal permits deferral of IFRS 9 application until annual periods beginning on or after January 1, 2021 or until the new insurance contract standard becomes effective if this is an earlier date. The amendments also propose an option to apply the “overlay approach” to the presentation of qualifying financial assets, in which an entity would be permitted to remove from profit or loss and present instead in OCI, the impact of measuring financial assets at fair value through profit or loss under IFRS 9 when they would not have been so measured under IAS 39.

(b) Revenue from Contracts with Customers

In May 2014, the IASB issued IFRS 15 — Revenue from Contracts with Customers, which clarifies the principles for recognizing revenue and cash flows arising from contracts with customers. The standard is effective for annual periods beginning on or after January 1, 2018 and is to be applied retrospectively. The Company does not expect the standard to have a material impact on its consolidated financial statements.



3. STANDARDS ISSUED BUT NOT YET EFFECTIVE (continued)

(c) Leases

In January 2016, the IASB issued IFRS 16 — Leases, which establishes principles for the recognition, measurement, presentation and disclosure of leases. The standard provides a single lessee accounting model, requiring lessees to recognize assets and liabilities for all leases, unless the lease term is twelve months or less or the underlying asset has a low value. The standard is effective for annual periods beginning on or after January 1, 2019 and is to be applied retrospectively.

4. SIGNIFICANT ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS

The preparation of the Company’s consolidated financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities as at the reporting date and the reported amounts of revenues and expenses during the year. Actual results could differ from these estimates. Although some variability is inherent in these estimates, management believes that the amounts provided are reasonable. The most complex and significant judgments, estimates and assumptions used in preparing the Company’s consolidated financial statements are discussed below.

Judgments

In the process of applying the Company’s accounting policies, management has made the following judgments, which have the most significant effect on the amounts recognized in the consolidated financial statements.

The Company has applied judgment in its assessment of control or significant influence over investees, of the identification of objective evidence of impairment for financial instruments, the recoverability and recognition of tax losses, the determination of CGUs, the evaluation of current obligations requiring provisions and the identification of the indicators of impairment for property and equipment, goodwill and intangible assets.

Estimates and assumptions

The key assumptions concerning the future and other key sources of estimation uncertainty at the reporting date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are discussed below.

(a) Valuation of claim liabilities

The Company is required by applicable insurance laws, regulations and IFRS to establish liabilities for payment of claims and claims adjustment expenses that arise from the Company’s insurance products. These liabilities represent the expected ultimate cost to settle claims occurring prior to, but still outstanding as of, the reporting date. The Company establishes its claim liabilities by geographic region, product line, type and extent of coverage and year of occurrence.

Claim liabilities fall into two categories: reserves for reported claims and provision for IBNR losses. Additionally, liabilities are held for claims adjustment expenses, which contain the estimated legal and other expenses expected to be incurred to finalize the settlement of the losses.

Determining the provision for unpaid claims and adjustment expenses and the related reinsurers’ share involves an assessment of the future development of claims. The estimates are principally based on the Company’s historical experience. Methods of estimation have been used that the Company believes produce reasonable results given current information. This process takes into account the consistency of the Company’s claim handling procedures, the amount of information available, the characteristics of the line of business from which the claim arises, and the delays in reporting claims. Claim liabilities include estimates subject to variability, which could be material. Changes to the estimates could result from future events such as receiving additional claim information, changes in judicial interpretation of contracts or significant changes in severity or frequency of claims from past trends.

In general, the longer the term required for the settlement of a group of claims, the greater the potential for variability in the estimate. Any future changes in estimates would be reflected in the consolidated statement of comprehensive income in the year in which the change occurred. Note 8 contains additional analysis of the impact of the key assumptions on claim liabilities.

The principal assumptions made in establishing claim liabilities are best estimates. Claim liabilities have been discounted to reflect future investment income in accordance with Canadian accepted actuarial practice. The rate used to discount the claim liabilities is based on the fair value yield of the bond portfolio supporting the claim liabilities. To increase the likelihood that the claim liabilities are adequate to pay future benefits, margins for adverse deviation are required to be included for assumptions regarding future claims development, interest rates and reinsurance recoverables. The Canadian Institute of Actuaries recommends a range of appropriate margins for each of these variables. The combined effect of all the margins produces the PfAD.

Reinsurance recoverables include amounts for expected recoveries from reinsurers related to claim liabilities. Amounts recoverable from reinsurers are evaluated in a manner consistent with the provisions of the reinsurance contracts. The failure of reinsurers to honour their obligations could result in losses to the Company, as the ceding of insurance does not relieve the Company of its primary liability to its insured parties.

(b) Impairment of goodwill and intangible assets

The Company determines whether goodwill and intangible assets are impaired on an annual basis or more frequently if there are indicators of potential impairment. Impairment testing of goodwill and intangible assets requires an estimation of the recoverable amount of the CGUs to which the assets are allocated.



4. SIGNIFICANT ACCOUNTING JUDGMENTS, ESTIMATES AND ASSUMPTIONS (continued)

(c) Impairment of financial assets

The Company assesses its AFS financial instruments for objective evidence of impairment at each reporting date. Objective evidence of impairment includes a significant or prolonged decline in the fair value or net asset value below cost or when a loss event that has a reliably estimable impact on the future cash flows of the financial instrument has occurred. Significance of the decline is evaluated against the original cost of the investment and prolonged against the period in which the fair value has been below its original cost. The determination of what is significant or prolonged requires judgment. In making this judgment, the Company evaluates, among other factors, a decline in current financial position; defaults on debt obligations; failure to meet debt covenants; significant downgrades in credit status; and severity and/or duration of the decline in value.

(d) Control or significant influence over investees

The Company presumes that control or significant influence over an investee is evidenced primarily by the ownership percentage held of the investee unless there are other factors which indicate the level of control is not aligned with the ownership percentage. Currently there are no investments in investees for which the assessment of control or significant influence is not aligned with the ownership percentage.

(e) Valuation of post-employment benefits obligation

The projected cost of defined benefit pension plans and other non-pension future benefits is determined using actuarial valuations performed by external pension actuaries. No estimation is required for the defined contribution pension plan given the plan structure. The actuarial valuation involves making assumptions about discount rates, future salary increases, mortality rate, expected health care costs, inflation and future pension increases. The details of the assumptions are disclosed in note 17. Due to the long-term nature of these plans, such estimates are subject to significant uncertainty. Actual experience that differs from the assumptions will affect the amounts of the benefit obligation recognized in the consolidated balance sheet, the expense recognized in net income and actuarial gains or losses recognized in OCI in the consolidated statement of comprehensive income.

(f) Provisions

Provisions, including restructuring provisions, are recognized when the Company determines that there is a present legal or constructive obligation as a result of a past event or decision, it is more likely than not that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Provisions are recorded at the present value of the expenditures expected to be required to settle the obligation. In estimating provisions, the Company must make assumptions regarding the timing and amount of the expenditures and determine an appropriate discount rate reflective of the current market assessment of the time value of money and the risks specific to the obligations.

(g) Measurement of income taxes

The Company is subject to income tax laws in various federal and provincial jurisdictions where it operates. Various tax laws are potentially subject to different interpretations by the taxpayer and the relevant tax authority. To the extent that the Company’s interpretations differ from those of tax authorities or the timing of realization is not as expected, the provision for income taxes may increase or decrease in future periods to reflect actual experience. The Company maintains provisions for uncertain tax positions that it believes appropriately reflect the risk of tax positions under discussion, audit dispute or appeal with tax authorities or which are otherwise considered to involve uncertainty.

5. INVESTMENTS

(a) Investment income and balances

Investment income by financial instrument classification is as follows:


(in thousands of dollars) 2015

Notes FVTPL AFS Loans and

receivables Total

Interest $ 36,423 $ 30,813 $ 408 $ 67,644

Dividends - 37,926 - 37,926

Realized gains on sale of investments 36,701 65,871 - 102,572

Net impairment losses on AFS investments 5(c) - (19,729) - (19,729)

Unrealized losses on FVTPL financial instruments (8,962) - - (8,962)

Recognized gains on investments 27,739 46,142 - 73,881

$ 64,162 $ 114,881 $ 408 $ 179,451


5. INVESTMENTS (continued)

(a) Investment income and balances (continued)


Notes FVTPL AFS Loans and

receivables Total

Interest $ 43,884 $ 31,340 $ 1,437 $ 76,661

Dividends - 29,515 - 29,515

Realized gains on sale of investments 13,298 34,872 - 48,170

Net impairment losses on AFS investments 5(c) - (4,696) - (4,696)

Unrealized gains on FVTPL financial instruments 14,591 - - 14,591

Recognized gains on investments 27,889 30,176 - 58,065

$ 71,773 $ 91,031 $ 1,437 $ 164,241

The fair value yield as at December 31, 2015 for the FVTPL bond portfolio was 1.34% (2014: 1.63%) and for the AFS bond portfolio was 2.53% (2014: 2.49%).

Investment carrying values by financial instrument classification are as follows:


FVTPL AFS Loans and

receivables Total

Short-term investments $ - $ 26,952 $ - $ 26,952

Bonds 1,770,936 1,199,037 - 2,969,973

Preferred stocks - 370,564 - 370,564

Common stocks - 558,202 - 558,202

Pooled funds - 114,220 - 114,220

Commercial loans - - 25,021 25,021

$ 1,770,936 $ 2,268,975 $ 25,021 $ 4,064,932


FVTPL AFS Loans and

receivables Total


Bonds 2,151,994 922,705 - 3,074,699

Preferred stocks - 412,077 - 412,077

Common stocks - 389,205 - 389,205

Pooled funds - 107,443 - 107,443

Commercial loans - - 38,091 38,091

$ 2,151,994 $ 1,871,312 $ 38,091 $ 4,061,397

The commercial loans have an amortized cost of $25.0 million (2014: $38.1 million) and fair value of $22.8 million (2014: $35.3 million).




(a) Investment income and balances (continued)

The unrealized gains (losses) on AFS investments are detailed below. The cost of all AFS investments, except AFS bonds, is the purchase price less cumulative impairment losses, if applicable. The cost of all AFS bonds is the amortized cost adjusted for cumulative impairment losses.


Cost/ amortized cost

Gross unrealized

gains

Gross unrealized

losses Fair value

Short-term investments $ 26,952 $ - $ - $ 26,952

Bonds:

Government 353,856 5,877 (708) 359,025

Corporate 828,762 14,860 (3,610) 840,012

1,182,618 20,737 (4,318) 1,199,037

Canadian preferred stocks 433,634 3,343 (66,413) 370,564

Common stocks:

Canadian 417,092 22,340 (14,063) 425,369

Foreign 79,100 53,908 (175) 132,833

Foreign pooled funds 113,918 302 - 114,220

610,110 76,550 (14,238) 672,422

$ 2,253,314 $ 100,630 $ (84,969) $ 2,268,975


Cost/ amortized cost

Gross unrealized

gains

Gross unrealized

losses Fair value

Short-term investments $ 39,882 $ - $ - $ 39,882

Bonds:

Government 347,125 11,665 (9) 358,781

Corporate 547,228 17,776 (1,080) 563,924

894,353 29,441 (1,089) 922,705

Canadian preferred stocks 408,388 7,298 (3,609) 412,077

Common stocks:

Canadian 231,884 50,013 (3,485) 278,412

Foreign 75,756 35,702 (665) 110,793

Foreign pooled funds 87,787 19,738 (82) 107,443

395,427 105,453 (4,232) 496,648

$ 1,738,050 $ 142,192 $ (8,930) $ 1,871,312

(b) Financial instruments measured at fair value

The Company categorizes its fair value measurements according to a three-level hierarchy, which 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 Company recognizes transfers between the levels of the fair value hierarchy at the end of the reporting period during which the change has occurred. The three levels of the fair value hierarchy are defined as follows:

(i) Level 1 fair value measurements reflect unadjusted, quoted prices in active markets for identical assets and liabilities that the Company has the ability to access at the measurement date. If an instrument classified as Level 1 subsequently ceases to be actively traded, it is transferred out of Level 1 and into Level 2 or Level 3 as appropriate. Included in the Level 1 category are all stocks, except the pooled funds.




(b) Financial instruments measured at fair value (continued)

(ii) Level 2 fair value measurements use 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 but are not prices such as interest rates and credit risks and inputs that are derived from or corroborated by observable market data. Included in the Level 2 category are all bonds which are valued on a discounted cash flow basis, the pooled funds which are valued based on quoted prices of the underlying securities in an active market and short-term investments which are valued on a discounted cash flow basis. The inputs into the discounted cash flow model for the bonds and short-term investments are an estimate of the expected cash flows discounted at a pre-tax risk-free rate plus an appropriate adjustment for credit risk.

(iii) Level 3 fair value measurements use significant non-market observable inputs, including assumptions about risk or liquidity. As at December 31, 2015, the Company has no financial instruments in this category (2014: nil). Commercial loans are measured at cost but fair value is disclosed. The fair value is measured on a discounted cash flow basis. The inputs into the discounted cash flow model are an estimate of the expected cash flows discounted at a pre-tax risk-free rate plus an appropriate adjustment for credit risk.

Distribution of financial instruments measured at fair value in the three-level hierarchy is as follows:


Level 1 Level 2 Level 3 Total


Bonds - 2,969,973 - 2,969,973

Preferred stocks 370,564 - - 370,564

Common stocks 558,202 - - 558,202

Pooled funds - 114,220 - 114,220

$ 928,766 $ 3,111,145 $ - $ 4,039,911


Level 1 Level 2 Level 3 Total


Bonds - 3,074,699 - 3,074,699

Preferred stocks 412,077 - - 412,077

Common stocks 389,205 - - 389,205

Pooled funds - 107,443 - 107,443

$ 801,282 $ 3,222,024 $ - $ 4,023,306

There were no transfers of financial instruments between the levels during the year.

(c) Impairment review

Impairment reclassification of unrealized losses (recoveries) from AOCI to net income is as follows:

(in thousands of dollars) 2015 2014

Common stocks:

Canadian $ 19,113 $ 6,760

Foreign 616 1,148

Bonds:

Corporate - (3,212)

$ 19,729 $ 4,696

The remaining gross unrealized losses of $85.0 million (2014: $8.9 million) on the AFS investments have not been recognized in net income as the Company does not believe there is currently objective evidence of impairment.

The Company has determined that there is no evidence of significant impairment of any individual commercial loan because all balances are current and a review of the financial condition of the debtor and pledged collateral indicates that there is reasonable assurance of timely collection of the full amount of principal and interest.




(d) Securities lending

The Company participates in a securities lending program managed by a major Canadian and US financial institution, whereby the Company lends securities it owns to other financial institutions to allow them to meet delivery commitments. The lending agents assume the risk of borrower default associated with the lending activity. As at December 31, 2015, securities with an estimated fair value of $509.3 million (2014: $590.3 million) have been loaned and securities with an estimated fair value of $524.6 million (2014: $603.9 million) have been received as collateral from the financial institutions. Lending collateral as at December 31, 2015 was 100.0% (2014: 100.0%) held in cash and government-backed securities. The securities loaned under this program have not been removed from “Investments” on the consolidated balance sheet because the Company retains the risks and rewards of ownership.

The financial compensation the Company receives in exchange for securities lending is reflected in the consolidated statement of comprehensive income in “Interest”.

(e) Embedded derivatives

At least annually, the Company conducts a search for embedded derivatives within its significant contracts. No significant embedded derivatives were identified that required bifurcation.

6. NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS

The Company’s financial instruments, including investments, are exposed to interest rate risk, equity market price risk, credit risk, foreign exchange risk and liquidity risk. The Company’s Statement of Investment Policies and Procedures (“SIP&P”) establishes asset mix parameters and risk limits which minimize undue exposure to these risks in the investment portfolio. The SIP&P is reviewed at least annually by the Investment Committee of the Board of Directors. Compliance with the SIP&P is monitored quarterly by the Investment Committee.

(a) Interest rate risk

Interest rate risk arises from the possibility that changes in interest rates will affect future cash flows or the fair values of financial instruments. Typically, interest income will be reduced during sustained periods of declining interest rates, but this will also generally increase the fair value of the bond portfolio. The reverse is true during a sustained period of increasing interest rates. As interest rate risk is a significant risk to the Company due to the nature of its investments and claim liabilities, a portion of the Company’s bond portfolio has been voluntarily designated as FVTPL financial assets, and is managed to mitigate the effect of interest rate changes on the Company’s claim liabilities. The effect of interest rate risk associated with discounting claim liabilities is disclosed in note 8.

The impact of an immediate hypothetical 1% change in interest rates, on the FVTPL and AFS bond portfolios, with all other variables held constant is as follows:

(in thousands of dollars)

Impact on:

2015 2014

+1% -1% +1% -1%

Fair value of FVTPL bonds and income before income taxes $ (67,034) $ 74,243 $ (66,560) $ 72,459

Fair value of AFS bonds and OCI before income taxes $ (62,264) $ 75,140 $ (43,946) $ 51,349

The estimated impact on income taxes would be calculated at the statutory rate of 26.71% (2014: 26.4%).

(b) Common equity market price risk and preferred stock price risk

Economic trends, the political environment and other factors can positively or adversely impact the equity markets and consequently the value of equity investments the Company holds. The Company’s AFS portfolio includes Canadian common stocks with fair value movements that are benchmarked against movements in the Toronto Stock Exchange Composite Index, and foreign stocks and pooled funds with fair values that are benchmarked against movements in the Morgan Stanley Capital International Index. Also included in the AFS portfolio are the Company’s holdings of preferred stocks.

The impact of a 10% movement in equity markets to the value of the Company’s equity portfolio, with all other variables held constant, to the extent the Company does not dispose of any of these equities during the year, is as follows:


Impact on:

2015 2014

+ 10% - 10% + 10% - 10%

Fair value of Canadian stocks and OCI before income taxes $ 34,880 $ (34,880) $ 21,995 $ (21,995)

Fair value of preferred stocks and OCI before income taxes $ 37,057 $ (37,057) $ 41,207 $ (41,207)

Fair value of foreign stocks, pooled funds and OCI before income taxes $ 24,705 $ (24,705) $ 21,824 $ (21,824)

The estimated impact on income taxes would be calculated at the statutory rate of 26.71% (2014: 26.4%).



6. NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS (continued)

(c) Credit risk

Credit risk is the risk of financial loss caused by the Company’s counterparties not being able to meet payment obligations as they become due. The Company’s credit risk is concentrated in the bond, preferred stock and commercial loan portfolios, the securities lending program, premiums receivable, amounts owing from reinsurers and structured settlements. Unless otherwise stated, the Company’s credit exposure is limited to the carrying amount of these assets.

Bonds and preferred stocks

The Company’s SIP&P requires the Company to invest in bonds and preferred stocks of high credit quality and to limit exposure with respect to any one issuer. On a regular basis, the Company also monitors publicly available information referencing the investments held in the investment portfolio to determine whether there are investments which require closer monitoring of the credit risk. Of the bonds held as at December 31, 2015, 92.0% (2014: 92.4%) were rated “A-” or better and 88.1% (2014: 83.5%) of the preferred stocks were rated “P2” or better. “A-” and “P2” represent the ratings provided by two recognized rating services for high-grade bonds and preferred stocks, respectively, where both asset and earnings protection are well assured. Of the corporate bonds held, 75.0% (2014: 81.3%) are concentrated in the financial services industry, 8.1% (2014: 6.5%) are concentrated in industrial and 16.9% (2014: 12.2%) are in other industries. Of the preferred stocks and bonds held, the country of issuer is concentrated as 90.8% (2014: 94.9%) in Canada, 5.5% (2014: 3.8%) in the US and 3.7% (2014: 1.3%) in other countries.

Securities lending

As disclosed in note 5, the Company participates in a securities lending program. The Company minimizes credit risk associated with this program by only dealing with counterparties who are rated “A+” or higher by independent rating agencies and by obtaining collateral with a fair value in excess of the value of the securities loaned under the program. The ratio of fair value of collateral obtained in excess of the fair value of the securities loaned as at December 31, 2015 is 103.0% (2014: 102.3%).

Premiums receivable

The Company’s credit exposure to any one individual policyholder or broker included in premiums receivable is not significant. The Company regularly monitors amounts due from policyholders and follows up on all overdue accounts. As permitted by regulation, when premiums are overdue for an extended period of time the Company cancels the insurance coverage under the applicable policy. Before a broker is granted a contract, appropriate reviews are conducted by the Company. Delinquent accounts are regularly monitored and the Company takes action against non-payment. The allowance for doubtful accounts in the current and comparative periods is insignificant as overdue receivables are negligible.

Commercial loans

The Company periodically issues commercial loans to brokers. Sufficient collateral, in the form of an assignment over the ownership interest in the brokerage, is held to protect the Company against default on these loans. Annual financial reviews are undertaken to determine if the broker will be able to make the required payments when due. The Company’s gross credit exposure on these loans is limited to the carrying value of commercial loans as disclosed in note 5. There is currently no evidence of significant impairment of any individual commercial loan.

Reinsurance receivable and recoverable

Credit exposures on the Company’s reinsurance receivable and recoverable balances exist to the extent that any reinsurer may or may not be willing or able to reimburse the Company under the terms of the relevant reinsurance arrangements. The Company has policies which limit the exposure to individual reinsurers and a regular review process to assess the creditworthiness of reinsurers with whom the Company purchases coverage. The Company’s reinsurance risk management policy generally precludes the use of reinsurers with credit ratings less than “A-”.

Currently, all reinsurers have a credit rating of “A-” or better as determined by independent rating agencies. Where appropriate, the Company obtains collateral for outstanding balances in the form of cash, letters of credit, offsetting balances payable, guarantees or assets held under reinsurance security agreements. The Company has recorded an allowance for losses on reinsurance receivable and recoverable of $0.5 million (2014: $0.5 million).

Structured settlements

The Company has purchased annuities from life insurers to provide for fixed and recurring payments to claimants. As a result of these arrangements, the Company is exposed to credit risk to the extent to which any of the life insurers fail to fulfill their obligations. This risk is managed by acquiring annuities from life insurers with proven financial stability, all of which are rated “A-” or better by independent rating agencies. As at December 31, 2015, no information has come to the Company’s attention that would suggest any weakness or failure in life insurers from which it has purchased annuities. Consequently, no provision for credit risk is required. The original purchase price of the outstanding annuities is $271.9 million (2014: $262.0 million).

(d) Foreign exchange risk

Foreign exchange risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates. The Company’s foreign exchange risk relates primarily to its foreign common stock and pooled fund holdings in the AFS portfolio which are denominated in various foreign currencies.

The Company’s only significant foreign currency exposure is the US dollar. The impact on the fair value of US dollar foreign stocks, pooled funds and OCI before income taxes from a 10% change in the US dollar relative to the Canadian dollar is $11.2 million (2014: $9.0 million). Under this same scenario, the impact on the fair value of non-US dollar foreign stocks, pooled funds and OCI before income taxes is $6.1 million (2014: $4.9 million) assuming historical correlations between currency pairs remain intact. The estimated impact on income taxes would be calculated at the statutory rate of 26.71% (2014: 26.4%).




(e) Liquidity risk

Liquidity risk is the risk of having insufficient cash resources to meet current financial obligations. Liquidity risk arises from the Company’s general business activities and in the course of managing its assets and liabilities. The liquidity requirements of the Company’s business are met primarily by funds generated by operations, asset maturities and investment returns. Cash provided from these sources normally exceeds cash requirements to meet claim payments and operating expenses.

As at December 31, 2015, the Company has $89.0 million (2014: $89.2 million) of cash and cash equivalents and short-term investments of $27.0 million (2014: $39.9 million). The Company also has a highly liquid investment portfolio. As at December 31, 2015, Canadian fixed-income investments issued or guaranteed by domestic governments, investment-grade corporate bonds, publicly traded Canadian and foreign equities and the pooled funds have a fair value of $3,944.2 million (2014: $3,891.1 million).

The table below summarizes the maturity profile of the financial assets and financial liabilities of the Company.

For claim liabilities and reinsurance receivable and recoverable, maturity profiles are determined based on estimated timing of net cash flows on an undiscounted basis. DPAE, UPR and the reinsurers’ share of UPR have been excluded from the analysis as they are not of themselves contractual obligations.


Less than 1 year 1-5 years 6-10 years 10 years + Total

Assets:

Cash and cash equivalents $ 89,010 $ - $ - $ - $ 89,010

Short-term investments 26,952 - - - 26,952

FVTPL bonds 57,555 1,278,110 435,271 - 1,770,936

AFS bonds 62,764 444,426 569,232 122,615 1,199,037

Preferred stocks 78,916 278,973 12,675 - 370,564

Commercial loans 5,268 12,631 7,122 - 25,021

Accrued investment income 15,892 - - - 15,892

Premiums receivable 597,846 3,315 - - 601,161

Income taxes receivable 16,098 - - - 16,098

Reinsurance receivable and recoverable 35,006 30,942 6,185 731 72,864

$ 985,307 $ 2,048,397 $ 1,030,485 $ 123,346 $ 4,187,535

Liabilities:

Claim liabilities $ 642,862 $ 1,046,038 $ 381,979 $ 121,143 $ 2,192,022

Accounts payable and other liabilities 180,587 6,664 8,766 38,450 234,467

$ 823,449 $ 1,052,702 $ 390,745 $ 159,593 $ 2,426,489




(e) Liquidity risk (continued)



Assets:

Cash and cash equivalents $ 89,152 $ - $ - $ - $ 89,152

Short-term investments 39,882 - - - 39,882

FVTPL bonds 161,676 1,931,258 59,060 - 2,151,994

AFS bonds 42,341 283,205 519,812 77,347 922,705

Preferred stocks 42,794 322,583 46,700 - 412,077

Commercial loans 7,261 26,740 4,090 - 38,091

Accrued investment income 14,398 - - - 14,398

Premiums receivable 578,861 2,851 - - 581,712

Reinsurance receivable and recoverable 42,324 36,350 8,499 1,074 88,247

$ 1,018,689 $ 2,602,987 $ 638,161 $ 78,421 $ 4,338,258

Liabilities:

Claim liabilities $ 674,336 $ 1,069,829 $ 388,286 $ 112,355 $ 2,244,806

Accounts payable and other liabilities 127,149 9,006 10,138 44,389 190,682

Income taxes payable 311 - - - 311

$ 801,796 $ 1,078,835 $ 398,424 $ 156,744 $ 2,435,799

Note 17(c) contains the maturity profile for other post-employment benefit obligations.

The Company believes that it has the flexibility to obtain the funds needed to meet cash and regulatory requirements on an ongoing basis.

7. POLICY LIABILITIES

These consolidated financial statements contain an actuarial estimate of the policy liabilities of the Company. Policy liabilities represent the amount of the obligation of the Company on account of policies effective on or before the reporting date and consist of premium and claim liabilities. Claim liabilities are associated with claims that have occurred on or before December 31, 2015, whether the claim has been reported to the Company at that time or not, whereas premium liabilities are associated with claims that may occur in the future on policies in force on December 31, 2015.

(a) Premium liabilities

Premium liabilities are represented by the amount of net UPR less the amount of net DPAE. Generally, the commissions and premium taxes corresponding to the net UPR are deferrable; however, this amount is written down if the resulting expected future net policy costs are greater than the net UPR. No write-down to DPAE is required for the year ended December 31, 2015 (2014: nil).

The following changes have occurred in UPR during the year:


Gross Ceded Net Gross Ceded Net

UPR, beginning of year $ 995,486 $ 11,495 $ 983,991 $ 971,762 $ 20,290 $ 951,472

Premiums written during year 2,008,387 73,035 1,935,352 1,963,043 85,242 1,877,801

Premiums earned during year (1,981,534) (75,879) (1,905,655) (1,939,319) (94,037) (1,845,282)

UPR, end of year $ 1,022,339 $ 8,651 $ 1,013,688 $ 995,486 $ 11,495 $ 983,991



7. POLICY LIABILITIES (continued)

(a) Premium liabilities (continued)

The following changes have occurred in the DPAE during the year:


DPAE, beginning of year $ 202,780 $ 196,805

Acquisition costs deferred 386,065 378,081

Amortization of acquisition costs (381,008) (372,106)

DPAE, end of year $ 207,837 $ 202,780

The following table presents the Company’s UPR by line of business as at December 31.


Gross UPR Ceded UPR Net UPR

Personal lines:

Automobile $ 440,361 $ - $ 440,361

Property 205,086 - 205,086

645,447 - 645,447

Commercial lines:

Automobile 130,868 1,809 129,059

Property and liability 246,024 6,842 239,182

376,892 8,651 368,241

$ 1,022,339 $ 8,651 $ 1,013,688


Gross UPR Ceded UPR Net UPR

Personal lines:

Automobile $ 409,092 $ - $ 409,092

Property 194,175 - 194,175

603,267 - 603,267

Commercial lines:

Automobile 131,847 3,024 128,823


392,219 11,495 380,724

$ 995,486 $ 11,495 $ 983,991

(b) Claim liabilities

Claim liabilities are established to reflect the estimate of the full amount of all liabilities associated with the insurance contracts at the end of the year, including IBNR. The ultimate cost of these liabilities will vary from the best estimate made for a variety of reasons, including additional information with respect to the facts and circumstances of the claims incurred. Note 4 contains additional information on the judgments, estimates and assumptions used in determining claim liabilities. The discount rate as at December 31, 2015 used to discount the claim liabilities was 1.47% (2014: 1.63%).




(b) Claim liabilities (continued)

The following table presents the movement of the Company’s claim liabilities during the year.


Gross claim liabilities

Ceded claim liabilities

Net claim liabilities

Claim liabilities, beginning of year $ 2,361,208 $ 84,355 $ 2,276,853

Current year claims incurred 1,308,049 13,451 1,294,598

Prior year favourable claims development (61,830) 11,318 (73,148)

1,246,219 24,769 1,221,450

Increase due to discounting (including PfAD) 840 (648) 1,488

Claims and adjustment expenses 1,247,059 24,121 1,222,938

Claims paid during the year 1,299,002 37,030 1,261,972

Claim liabilities, end of year $ 2,309,265 $ 71,446 $ 2,237,819





Claim liabilities, beginning of year $ 2,341,776 $ 135,745 $ 2,206,031

Current year claims incurred 1,295,456 11,366 1,284,090

Prior year favourable claims development (2,490) 397 (2,887)

1,292,966 11,763 1,281,203

Increase due to discounting (including PfAD) 14,198 (1,873) 16,071

Claims and adjustment expenses 1,307,164 9,890 1,297,274

Claims paid during the year 1,287,732 61,280 1,226,452

Claim liabilities, end of year $ 2,361,208 $ 84,355 $ 2,276,853

The following table presents the Company’s claim liabilities by line of business as at December 31.





Personal lines:

Automobile $ 1,371,705 $ 11,181 $ 1,360,524

Property 100,060 784 99,276

1,471,765 11,965 1,459,800

Commercial lines:

Automobile 350,385 24,017 326,368


837,500 59,481 778,019

$ 2,309,265 $ 71,446 $ 2,237,819




(b) Claim liabilities (continued)





Personal lines:

Automobile $ 1,408,403 $ 12,693 $ 1,395,710

Property 107,720 1,722 105,998

1,516,123 14,415 1,501,708

Commercial lines:

Automobile 345,518 21,628 323,890


845,085 69,940 775,145

$ 2,361,208 $ 84,355 $ 2,276,853

8. NATURE AND EXTENT OF RISKS ARISING FROM INSURANCE CONTRACTS

(a) Insurance risk management

By the very nature of an insurance contract, there is uncertainty as to whether an insured event will occur and the amount of loss that would arise in such an event. In the course of these insurance activities, there are several risks the Company must address by applying appropriate underwriting and claims policies and processes.

The Company’s exposure to concentrations of insurance risk, in terms of type of risk and level of insured benefits, is mitigated by the use of predictive analytics, underwriting policies and individual limits. The Company carefully assesses individual risk attributes and characteristics in building an insurance portfolio with appropriate risk levels.

The concentration of written premiums by line of business and geographical region are as follows:

2015 2014

Personal automobile 42.8% 41.3%

Personal property 19.4% 18.9%

Commercial automobile 13.2% 13.6%

Commercial property and liability 24.6% 26.2%

100.0% 100.0%

2015 2014

Ontario 57.4% 57.1%

British Columbia 14.8% 14.8%

Alberta & Prairies 14.5% 14.5%

Atlantic 6.8% 7.2%

Quebec 6.3% 6.2%

Out of Canada 0.2% 0.2%

100.0% 100.0%

The following discussion outlines the most significant insurance risks and the practices employed to mitigate these risks.

(i) Product and pricing risk

Product and pricing risk is the risk of financial loss from entering into insurance contracts when the liabilities assumed exceed the expectation reflected in the pricing of the insurance product. The Company prices its products by taking into account several factors including product design and features, claim frequency and severity trends, product line expense ratios, special risk factors, capital requirements, regulatory requirements and investment income. These factors are reviewed and adjusted as needed to ensure they are reflective of current trends and market conditions. The Company endeavours to maintain pricing levels that produce an acceptable return by appropriately measuring and incorporating these factors into its pricing decisions.



8. NATURE AND EXTENT OF RISKS ARISING FROM INSURANCE CONTRACTS (continued)

(a) Insurance risk management (continued)

(ii) Underwriting risk

Underwriting risk is the risk of financial loss resulting from the selection of risks to be insured and the management of contract clauses. To minimize underwriting risk, the Company has underwriting policies that set out the underwriting risk appetite and criteria, as well as specified tolerances for maximum financial risk retention. Once the retention limits are reached, reinsurance is utilized to cover the excess risk. The Company annually reviews the adequacy of its reinsurance programs to ensure sufficient reinsurance protection and financial return.

The Company has established quality review processes to ensure that the underwriting activities fall within established guidelines, risk appetites, and pricing structures. The results of these quality reviews are shared with the appropriate field management staff to ensure any issues identified are remedied.

(iii) Claims risk

Claims risk is the risk that inappropriate claims payments are made as a result of inadequate adjudication, settlement or payment of claims. Strict claim review policies are in place to assess all new and ongoing claims. In addition, regular detailed review of claims handling procedures and frequent investigation of possible fraudulent claims attempts to manage the claims risk exposure of the Company. Further, the Company enforces a policy of actively managing and promptly responding to claims in order to reduce its exposure to unpredictable future developments that could negatively impact claims settlement.

The Company has also limited its exposure by imposing maximum claim amounts on certain contracts as well as the use of reinsurance arrangements in order to limit exposure to large losses and catastrophic events. The placement of ceded reinsurance is almost exclusively on an excess-of-loss basis (per event or per risk). Under such programs, management considers that in order for a contract to reduce exposure to risk, it must be structured to ensure that the reinsurer assumes significant insurance risk related to the underlying reinsured contracts and it is reasonably possible that the reinsurer may realize a significant loss from reinsurance.

(iv) Interest rate risk

As the outstanding claim liabilities represent payments that will be made in the future, they are discounted to reflect the time value of money, effectively recognizing that the bonds held to support insurance liabilities will earn a return during that period. The discount rate used to discount the actuarial value of claim liabilities is based on the fair value yield of the Company’s bonds that support the claim liabilities (note 5). In assessing the risks associated with investment income and therefore the discount rate, the Company considers the nature of the bond portfolio and the timing of claim payments and their matching to investment cash flows. Future changes in the bond portfolio could change the value of claim liabilities by impacting the fair value yield.

The following table presents the interest rate sensitivity analysis for a 1% change in interest rates on the net claim liabilities:


Impact on:

2015 2014

+1% -1% +1% -1%

Net claim liabilities $ (67,282) $ 72,463 $ (66,709) $ 71,673

(v) Regulatory risk

The P&C industry is subject to significant government regulation. As a result it is possible that future regulatory changes or changes in interpretations may limit the Company’s ability to adjust prices, adjudicate claims or take other actions that would enhance operating results. The Company seeks to mitigate this risk through regular discussions with regulators and P&C industry groups to ensure the Company is aware of proposed changes and by providing feedback to regulators on proposed changes. The Company monitors compliance with relevant regulations and considers the implications of potential changes in regulation or interpretation on future results. Note 18 provides information on regulatory capital requirements. Note 19 provides additional details on rate regulation.

(b) Uncertainty and assumptions related to insurance contracts

A key objective of the Company is to ensure that sufficient claim liabilities are established to cover future insurance claim payments. The Company’s underwriting profitability depends upon the ability to accurately assess the risk associated with the insurance contracts underwritten by the Company. The Company establishes claim liabilities to cover the estimated liability for payment of all claims and claims adjustment expenses incurred with respect to insurance contracts underwritten by the Company. Claim liabilities do not represent an exact calculation of the liability. Rather, claim liabilities are the Company’s best estimates of the expected ultimate cost of resolution and administration of claims. Expected inflation is taken into account when estimating claim liabilities, thereby mitigating inflation risk.

Claim liabilities include an estimate for reported claims as established by the Company’s claims adjusters based upon the details of reported claims plus a provision for IBNR.

Individual claims estimates are determined by claims adjusters on a case-by-case basis in accordance with documented policies and procedures. These specialists apply their knowledge and expertise, after taking available information regarding the circumstances of the claim into account, to set individual case reserve estimates. The claims reserving strategy and monitoring of their application and effectiveness falls under the accountability of the claims department.

The IBNR provision is intended to cover future development on both reported claims and claims that have occurred but have not yet been reported. Uncertainty exists on reported claims in that all information may not be available at the valuation date. Claims that have occurred may not be reported to the Company immediately; therefore, estimates are made to provide for unreported claims.




(b) Uncertainty and assumptions related to insurance contracts (continued)

The valuation of claim liabilities is based on estimates derived by geographical region and line of business using generally accepted actuarial techniques. Numerous individual assumptions that impact average claim costs or frequency of late reported claims are made for each line of business. The principal assumption in the majority of actuarial techniques employed is that future claims development will follow a pattern similar to recent historical experience. However, there are times where historical experience is deemed inappropriate for evaluating future development due to recent judicial decisions, changes to government legislation or major shifts in a book of business. Such instances can require significant actuarial judgment, often supported by industry benchmarks, in establishing an adequate provision for claim liabilities.

Establishing an appropriate level of claim liabilities is an inherently uncertain process and is closely monitored by the Company’s actuarial department. The sheer volume and diversity of considerations makes it impracticable to measure the impact on the Company’s insurance contracts resulting from a change in a particular assumption or group of assumptions. The analysis below demonstrates the impact of changing assumptions for all lines of business and geographical regions in such a way that the average claim severity and frequency is altered materially. The analysis below also isolates the impact within the average claims severity of a change in internal claims expenses on claim liabilities. The impacts below are on the reported claim liabilities as at December 31.


Impact of change in net claim liabilities due to:

2015 2014

+5% -5% +5% -5%

Change in average claims severity $ 111,891 $ (111,891) $ 113,843 $ (113,843)

Change in frequency on unreported claims $ 8,313 $ (8,313) $ 6,163 $ (6,163)

Change in internal claims expenses $ 6,566 $ (6,566) $ 6,726 $ (6,726)

Assumptions and methods of estimation have been used that the Company believes produce reasonable results given current information. As additional experience and other data become available, the estimates could be revised. Any future changes in estimates would be reflected in the consolidated statement of comprehensive income in the year in which the change occurred.




(b) Uncertainty and assumptions related to insurance contracts (continued)

The following table shows the development of claims over a period of time. The table reflects development for net claims, which is gross claims less reinsurance recoveries. The triangle in the table (“Estimate of ultimate claims”) shows how the ultimate estimates of total claims for each accident year develop over time as more information becomes known regarding individual claims and overall claims frequency and severity. Each column tracks the claims relating to a particular “accident year” which is the year in which such loss events occurred, regardless of when they were reported. The rows reflect the estimates in subsequent years for each accident year’s claims. Claims are presented on an undiscounted basis in the triangle. “Cumulative claims paid” in the table presents the cumulative amounts paid for claims for each accident year as at December 31, 2015.

The Company applied the transitional rules of IFRS 4 — Insurance Contracts in 2011 that permit less than ten years of information to be disclosed upon adoption of IFRS. The claims development information disclosed is being increased from five years to ten years over the period 2011 to 2016.

The claims development table excludes the FA, RSP/PRR and the effect of discounting (including PfAD), which are shown as separate reconciling items below the table.

Claims development table, net of reinsurance:

(in thousands of

dollars)

Accident Year

2006 and prior 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total

Estimate of ultimate claims

At end of accident year $2,658,948

$1,295,586

$1,473,388

$1,401,630

$ 1,198,256

$ 1,129,584 $1,058,577

$1,224,981

$1,258,496

$1,273,526 1 year later 2,627,963 1,280,821 1,432,320 1,352,544 1,085,810 1,038,734

1,005,550 1,211,859 1,241,147

2 years later 2,600,618 1,264,745

1,422,564 1,349,179 1,086,656 1,031,543 1,003,497 1,211,541

3 years later 2,599,881 1,265,880 1,410,738 1,368,331 1,088,028 1,050,942 1,003,389

4 years later 2,606,256 1,264,813 1,427,118 1,367,656 1,099,605 1,047,484

5 years later 2,611,648 1,273,663 1,427,746 1,364,157 1,097,641

6 years later 2,618,062 1,275,879 1,421,896 1,352,093

7 years later 2,618,160 1,268,970 1,413,038

8 years later 2,618,609 1,257,162

9 years later 2,614,830

Favourable development recognized in the year, undiscounted 3,779 11,808 8,858 12,064 1,964 3,458 108 318 17,349 $ 59,706

Favourable development recognized from FA and RSP/PRR ceded and assumed in the year 13,442

Total favourable development recognized in the year $ 73,148

Reconciliation to the consolidated balance sheet

Current estimate of ultimate claims $ 2,614,830 $ 1,257,162 $ 1,413,038

$1,352,093

$ 1,097,641

$1,047,484 $1,003,389 $ 1,211,541

$ 1,241,147

$1,273,526

$13,511,851

Cumulative claims paid 2,507,174 1,219,002 1,346,275 1,243,825 979,606 904,740 819,626 930,144 847,324 639,398 11,437,114

Current unpaid and unreported claims before discounting 107,656 38,160 66,763 108,268 118,035 142,744 183,763 281,397 393,823 634,128 2,074,737

Impact of discounting (including PfAD) 115,015

FA and RSP/PRR ceded and assumed, unpaid and unreported 48,067

Unpaid and unreported claims, net of reinsurance $2,237,819



9. REINSURANCE CONTRACTS

The Company follows the policy of underwriting and reinsuring contracts of insurance which limits the liability of the Company for individual large losses and in the event of a series of claims arising out of a single occurrence. These limits are as follows:


Individual loss

Property

Net company retention $ 3,000 $ 3,000

Maximum limit 40,000 40,000

Auto and general liability

Net company retention 4,000 4,000

Maximum limit 30,000 30,000

Catastrophe — primary

Net company retentions1 30,000 30,000

Maximum limit 1,400,000 1,600,000

1 In addition to $30.0 million (2014: $30.0 million) of net retention, the Company has a maximum $70.0 million (2014: $72.0 million) participation in higher layers of the treaty.

In addition, the Company has purchased facultative reinsurance coverage as required in line with its underwriting guidelines.

(a) Underwriting impact of reinsurance contracts

The following amounts relate to reinsurance ceded recorded in the consolidated statement of comprehensive income:

(in thousands of dollars) Notes 2015 2014

Premiums ceded 7,16 $ 73,035 $ 85,242

Premiums earned 7,16 75,879 94,037

Claims and adjustment expenses 7,8 24,121 9,890

Commissions 4,664 6,147

The following amounts relate to reinsurance assumed recorded in the consolidated statement of comprehensive income:


Premiums assumed 16 $ 4,411 $ 4,274

Premiums earned 7 4,040 8,116

Claims and adjustment expenses 7,8 8,383 4,949

Commissions 2,164 3,225

(b) Reinsurance receivable and recoverable

The amounts presented under reinsurance receivable and recoverable in the consolidated balance sheet represent the Company’s contractual rights under reinsurance contracts and are evaluated in a manner consistent with the gross liabilities.


Reinsurers’ share of UPR 7 $ 8,651 $ 11,495

Reinsurers’ share of claim liabilities 7,8 71,446 84,355

Reinsurer receivables 9,526 15,576

Reinsurer payables (5,879) (8,807)

Unearned reinsurance commissions (2,036) (2,594)

$ 81,708 $ 100,025



9. REINSURANCE CONTRACTS (continued)

(c) Reinsurance assumed contracts

The Company presents balances related to reinsurance assumed contracts in the same manner as it presents direct insurance business with the exception of reinsurance assumed receivables and payables which are presented in “Reinsurance receivable and recoverable”. The portion of assets and liabilities related to assumed contracts is as follows:

Reinsurance assumed assets:


DPAE 7 $ 859 $ 718

Reinsurance assumed receivables 396 1,704

$ 1,255 $ 2,422

Reinsurance assumed liabilities:


UPR 7 $ 2,261 $ 1,890

Claim liabilities 7 19,147 18,806

Reinsurance assumed payables 612 384

$ 22,020 $ 21,080

10. PROPERTY AND EQUIPMENT

Property and equipment, as presented on the consolidated balance sheet, is composed of the following:


Land and building

structure Building fixtures

Building infrastructure

Furniture and

equipment Computer equipment Total

Cost:

Balance, beginning of year $ 24,704 $ 9,859 $ 9,514 $ 20,351 $ 10,757 $ 75,185

Additions 3,686 579 2,697 2,193 1,767 10,922

Disposals (1,129) - - (10) (402) (1,541)

Balance, end of year $ 27,261 $ 10,438 $ 12,211 $ 22,534 $ 12,122 $ 84,566

Accumulated depreciation:


Depreciation charge 986 363 363 1,769 1,222 4,703

Depreciation on disposals (1,005) - - (10) (399) (1,414)


Net book value, end of year $ 19,376 $ 1,713 $ 5,178 $ 8,336 $ 4,029 $ 38,632



10. PROPERTY AND EQUIPMENT (continued)


Land and building

structure Building fixtures

Building infrastructure

Furniture and

equipment Computer equipment Total

Cost:


Additions 6,974 2 261 5,940 2,814 15,991

Disposals (363) - - (6,146) (679) (7,188)


Accumulated depreciation:


Depreciation charge 807 323 315 1,234 1,055 3,734

Depreciation on disposals (190) - - (5,995) (667) (6,852)


Net book value, end of year $ 16,800 $ 1,497 $ 2,844 $ 7,912 $ 3,487 $ 32,540

Depreciation charged to “Operating expenses” amounted to $4.7 million (2014: $3.7 million).

11. INCOME TAXES

(a) Income tax expense

The reconciliation of income tax calculated at the Canadian statutory tax rate to the income tax expense at the effective tax rate recorded in net income in the consolidated statement of comprehensive income is provided in the table below:


Income tax expense calculated based on statutory tax rates 26.7% $ 61,333 26.4% $ 27,702

Canadian dividend income not subject to tax (3.3%) (7,607) (5.6%) (5,810)

Effect of change in tax rates (0.1%) (260) 0.0% -

Non-deductible expenses 0.2% 435 0.6% 625

Rate differential on recognized gains on AFS equity instruments 0.1% 191 0.1% 109

Other (0.1%) (332) (1.8%) (1,884)

Income tax expense recorded in net income 23.5% $ 53,760 19.7% $ 20,742


Current income taxes $ 53,535 $ 14,213

Deferred income taxes 225 6,529

Income tax expense $ 53,760 $ 20,742

The major components of the current income tax expense are as follows:


Income taxes related to current year $ 51,400 $ 21,524

Income taxes related to prior years 2,135 (7,311)

$ 53,535 $ 14,213



11. INCOME TAXES (continued)

(a) Income tax expense (continued)

Income taxes included in OCI are as follows:


Items that may be reclassified subsequently to net income:

Net unrealized (losses) gains on AFS investments $ (19,245) $ 21,547

Reclassification to net income of net recognized gains on AFS investments (12,520) (8,061)

(31,765) 13,486

Items that will not be reclassified subsequently to net income:

Post-employment benefit obligation gain (loss) 1,618 (5,607)

Income tax (recovery) expense $ (30,147) $ 7,879

(b) Deferred income taxes

The components comprising net deferred income tax assets are as follows:


Net claim liabilities $ 29,886 $ 30,100

Post-employment benefit plans 11,516 12,730

DPAE 1,338 2,184

Property and equipment (3,281) (4,902)

Investments (23) (13)

Other 1,646 2,826

$ 41,082 $ 42,925

The components comprising deferred income tax expense (recovery) are as follows:


Net claim liabilities $ 214 $ (936)

Post-employment benefit plans (404) 763

DPAE 846 7,041

Property and equipment (1,621) (866)

Investments 10 (43)

Other 1,180 570

$ 225 $ 6,529

12. GOODWILL AND INTANGIBLE ASSETS

Goodwill and intangible assets, as presented on the consolidated balance sheet, is composed of the following items:


Goodwill $ 26,925 $ 26,925

Intangible assets 104,650 34,967

$ 131,575 $ 61,892



12. GOODWILL AND INTANGIBLE ASSETS (continued)

(a) Goodwill

Goodwill has been allocated to two individual CGUs. The carrying amount of goodwill allocated to each of the CGUs is shown below:


Economical Mutual Insurance Company $ 24,526 $ 24,526

Westmount Financial Inc. 2,399 2,399

$ 26,925 $ 26,925

Goodwill is subject to an impairment test that is performed at least annually. When testing for impairment, the recoverable amount of the CGU is determined based on VIU calculations using a discounted cash flow model based on financial forecasts approved by management covering a five-year period and an estimate of the terminal values for the period beyond the five-year forecast.

The key assumptions used for the impairment calculations are as follows:

• Growth rates represent the rates used to extrapolate new business contributions beyond the business plan period. The growth rate is based on historic performance adjusted for management expectations. The growth rate used for current year impairment calculations of 2.0% (2014: 2.0%) does not exceed the historic long-term average growth rate.

• A pre-tax, market adjusted discount rate of 9.6% (2014: 11.0%) is used to discount expected profits from future new business.

Management does not believe that a reasonable change in these assumptions would result in the carrying value of the CGUs exceeding the recoverable amounts.

The goodwill impairment testing for the current year determined that there was no evidence of impairment (2014: nil).

(b) Intangible assets


Software Other intangible

assets Total

Cost:

Balance, beginning of year $ 7,745 $ 57,304 $ 65,049

Additions 3,762 74,846 78,608

Disposals (68) - (68)

Impairment charge - (1,187) (1,187)

Balance, end of year $ 11,439 $ 130,963 $ 142,402

Accumulated amortization:


Amortization expense 1,978 5,759 7,737

Amortization on disposals (67) - (67)


Net book value, end of year $ 4,582 $ 100,068 $ 104,650



12. GOODWILL AND INTANGIBLE ASSETS (continued)

(b) Intangible assets (continued)


Software Other intangible

assets Total

Cost:


Additions 44 795 839

Disposals (44) - (44)


Accumulated amortization:


Amortization expense 1,310 5,676 6,986

Amortization on disposals (41) - (41)


Net book value, end of year $ 2,799 $ 32,168 $ 34,967

Included in intangible assets is $74.5 million (2014: $1.5 million) that has not yet commenced being amortized as the assets are still under development.

13. OTHER ASSETS

Other assets, as presented on the consolidated balance sheet, are composed of the following:


Investments in associates 14 $ 35,988 $ 19,449

Pension asset 17 10,095 15,494

Prepaid expenses and other 11,046 7,057

$ 57,129 $ 42,000

14. INVESTMENTS IN ASSOCIATES

The Company has only immaterial associates. Key financial information about the Company’s investments in immaterial associates is shown below, on a gross basis in aggregate:


Total assets $ 323,298 $ 237,144

Total liabilities 206,543 172,073

Total revenue 61,302 19,391

Total net income 22,910 3,630

The Company’s share of the comprehensive income of individually immaterial associates is $6.6 million (2014: $0.8 million).

Impairment testing for the Company’s investments in associates determined that an impairment loss was not required (2014: nil).

All of the Company’s investments in associates are private entities that are not traded on a public exchange. Therefore, there are no published price quotations for the fair value of these investments.



15. ACCOUNTS PAYABLE AND OTHER LIABILITIES

Accounts payable and other liabilities, as presented on the consolidated balance sheet, are composed of the following:


Pension and non-pension benefit obligations 17 $ 55,496 $ 65,243

Commissions payable 56,735 58,540

Premium taxes and other taxes payable 18,365 15,333

Accounts payable and other 102,163 48,413

Restructuring provision 1,708 3,153

$ 234,467 $ 190,682

16. PREMIUMS

Net premiums written, as presented on the consolidated statement of comprehensive income, is composed of the following:


Direct premiums written $ 2,003,976 $ 1,958,769

Premiums assumed from other companies 4,411 4,274

Gross premiums written 2,008,387 1,963,043

Premiums ceded to other companies (73,035) (85,242)

Net premiums written $ 1,935,352 $ 1,877,801

Net premiums earned, as presented on the consolidated statement of comprehensive income, is composed of the following:


Net premiums written $ 1,935,352 $ 1,877,801

Change in gross unearned premiums (26,853) (23,724)

Change in ceded unearned premiums (2,844) (8,795)

Net premiums earned $ 1,905,655 $ 1,845,282

17. POST-EMPLOYMENT BENEFITS

The Company provides certain pension and other post-employment benefits through defined benefit, defined contribution and other post-employment benefit plans to eligible participants upon retirement.

The contributory defined benefit pension plans provide pension benefits based on length of service and final average pensionable earnings. The most recent actuarial valuation was prepared as of January 1, 2015. The contribution to be paid by the Company is determined each year by the Company’s pension actuaries. The Company’s funding policy is to make contributions in amounts that are required to discharge the benefit obligations over the life of the plan. Discretionary pension contributions for the year ended December 31, 2015 were nil (2014: nil). Based on the latest actuarial valuations of all its plans, the total contributions by the Company to the pension plans are expected to be $1.0 million in 2016. The contributions are expected to be made in the form of cash. The plans are regulated by the Financial Services Commission of Ontario.

Plan assets associated with the pension plans are funded pursuant to a trust agreement through a trust company as selected by the Company. Ultimate responsibility for governance of the plan lies with the Company’s Board of Directors and specifically with the Investment Committee, and the Human Resources and Compensation Committee. Regular administration duties are delegated to the Management Pension Committee as appropriate.

Under the defined contribution component of the plan, the Company contributes a fixed percentage of an employee’s pensionable earnings to the plan. Contributions under the defined contribution component of the plan totalled $9.7 million (2014: $8.8 million).



17. POST-EMPLOYMENT BENEFITS (continued)

(a) Plan movements

The following table presents the movement of the Company’s pension plan and other benefit plan obligations and plan assets during the year.


Amounts recognized in

net income

(Gains) losses

recognized in OCI

Present value of benefit plan obligation

Fair value of plan assets

Other benefit plans

Pension plans

Pension plans


Total service cost $ 4,057 $ - 938 3,119 -

Interest cost 9,985 - 2,625 7,360 -

Interest income (6,517) - - - 6,517

Return on plan assets excluding interest income (1,532) 2,353 - - (821)

Curtailment - - - - -

Actuarial losses (gains)

Due to changes in demographic assumptions (27) (4) (31) - -

Due to changes in financial assumptions (90) (3,040) (5,834) 2,704 -

Due to experience losses - (5,364) (6,303) 939 -

Contributions by employer - - - - 3,678

Administration cost 651 - - - (651)

Contributions by plan participants - - - 449 449

Benefits paid - - (1,142) (8,941) (8,941)

Balance, end of year $ 6,527 $ (6,055) $ 55,496 $ 193,296 $ 203,391


Amounts recognized

in net income

(Gains) losses

recognized in OCI

Present value of benefit plan obligation

Fair value of plan assets

Other benefit plans Pension plans Pension plans


Total service cost $ 5,322 $ - 2,068 3,254 -

Interest cost 10,102 - 2,602 7,500 -

Interest income (2,794) - - - 2,794

Return on plan assets excluding interest income (6,039) (8,060) - - 14,099

Curtailment (1,508) - (201) (1,307) -

Actuarial (gains) losses

Due to changes in demographic assumptions (602) 1,330 249 479 -

Due to changes in financial assumptions (115) 28,453 7,659 20,679 -

Due to experience losses - (517) (517) - -

Contributions by employer - - - - 5,486

Administration cost 777 - - - (777)

Contributions by plan participants - - - 577 577

Benefits paid - - (1,147) (8,861) (8,861)

Balance, end of year $ 5,143 $ 21,206 $ 65,243 $ 187,666 $ 203,160

Of the amounts recognized in net income, $6.5 million (2014: $6.7 million) in expenses were recorded in “Operating expenses” and a curtailment gain of nil (2014: $1.5 million) were recorded in “Other income (expense)”.

The actual return on plan assets was $5.7 million (2014: $16.9 million).




(b) Funding status of defined benefit plans

The amounts recognized for pension plans in the consolidated balance sheet in “Other assets” at the reporting date are as follows:


Defined benefit obligation $ (193,296) $ (187,666)

Fair value of plan assets 203,391 203,160

Net defined benefit asset $ 10,095 $ 15,494

Actuarial losses (gains) on plan assets $ 2,353 $ (8,060)

Actuarial losses on plan liabilities $ 3,643 $ 21,158

The amounts recognized for other benefit plans in the consolidated balance sheet in “Accounts payable and other liabilities” at the reporting date are as follows:


Defined benefit obligation $ (55,496) $ (65,243)

Actuarial (gains) losses on plan liabilities $ (12,168) $ 7,391

(c) Maturity analysis of defined benefit obligations

The weighted average duration of the pension plan obligation is 15 years (2014: 16 years) and the weighted average duration of the other benefit plans obligation is 17 years (2014: 18 years).

The expected maturity of the defined benefit obligations are as follows:



Pension plans $ 7,818 $ 38,535 $ 39,564 $ 107,379 $ 193,296

Other benefit plans 1,616 6,664 8,766 38,450 55,496

$ 9,434 $ 45,199 $ 48,330 $ 145,829 $ 248,792



Pension plans $ 7,496 $ 37,763 $ 37,208 $ 105,199 $ 187,666

Other benefit plans 1,710 9,006 10,138 44,389 65,243

$ 9,206 $ 46,769 $ 47,346 $ 149,588 $ 252,909

(d) Pension plan asset allocation

The table below shows the allocation of defined benefit pension plan assets:


Cash $ 1,728 0.8% $ 1,128 0.6%

Canadian fixed income securities (investment grade)

Government of Canada 30,168 14.8 33,696 16.6

Provincial and municipal 29,043 14.3 22,803 11.2

Corporate 21,375 10.5 21,526 10.6

Pooled equity funds

Canadian 43,848 21.6 53,427 26.3

Foreign 69,908 34.4 63,196 31.1

Other 7,321 3.6 7,384 3.6

$ 203,391 100.0% $ 203,160 100.0%




(d) Pension plan asset allocation (continued)

Of the corporate bonds held in the pension plan, 58.5% (2014: 58.5%) are concentrated in the financial services industry, 25.8% (2014: 26.0%) are concentrated in industrial and 15.7% (2014: 15.5%) are in other industries.

The Company undertakes an asset-liability study as deemed necessary. The goal of the asset-liability study is to balance the expected long term cost of the plan with the risk tolerance of the Company. To achieve this balance, the assets in the plan are allocated to fixed income securities, foreign equities and Canadian equities.

(e) Assumptions applied

The principal actuarial assumptions used in determining the defined benefit obligation for the Company’s pension plans are follows:

Other benefit plans Pension plans

2015 2014 2015 2014

To determine benefit obligation, end of year:

Discount rate 3.9% 4.1% 3.9% 4.0%

Future salary increases - - 3.0% 3.0%

Future pension increases - - 0.0% 0.0%

Inflation assumption - - 2.0% 2.0%

Prescription drug cost increase 8.0% 8.6% - -

Medical claims cost increase 4.5% 4.5% - -

To determine benefit expense for the year:

Discount rate 4.1% 4.9% 4.0% 4.8%

Future salary increases - - 3.0% 3.0%

Future pension increases - - 0.0% 0.0%

Inflation assumption - - 2.0% 2.0%

Prescription drug cost increase 8.6% 8.8% - -

Medical claims cost increase 4.5% 4.5% - -

The mortality assumptions used to assess the Company’s defined benefit obligations for the pension and other post-employment benefit plans as of December 31, 2015 are based on the Canadian Pensioner Mortality — Private Sector mortality tables as established by the Canadian Institute of Actuaries.

The discount rate is the assumption that has the largest impact on the value of these obligations. The impact of a 1% change in this rate is as follows:


Impact on: +1% -1% +1% -1%

Defined benefit obligation — pension plans $ (24,634) $ 30,612 $ (25,677) $ 32,064

Defined benefit obligation — other benefit plans $ (7,980) $ 10,096 $ (9,815) $ 12,510

This impact is calculated by performing a calculation of the liabilities as at December 31, using a discount rate 1% higher or lower than the discount rate used, holding all other assumptions constant.

The impact of a 1% change in the health care cost assumption is as follows:


Impact on: +1% -1% +1% -1%

Defined benefit obligation — other benefit plans $ 9,010 $ (7,234) $ 12,312 $ (9,712)

Aggregate of total service cost and interest cost $ 482 $ (386) $ 956 $ (748)

This impact is calculated by performing a calculation of the liabilities as at December 31, using a health care cost 1% higher or lower than the health care cost increase used, holding all other assumptions constant.




(f) Risks arising from post-employment benefits

The key risks to which the Company is exposed to as a result of sponsoring the defined benefit pension plans and other post-employment benefit plans are as follows:

(i) Inflation risk — Inflation can increase the cost of benefits provided under post-employment benefits and result in higher benefit obligations. As the return on plan assets is indirectly influenced by inflation, an increase in inflation would not result in a corresponding increase in the value of plan assets.

(ii) Interest rate risk — Changes in interest rates will influence discount rates resulting in an inverse change in benefit obligations. For the defined benefit plan, interest rate changes would also have an inverse change on the fair value fixed income security assets thereby somewhat offsetting the impact of the change in discounting of the benefit obligations.

(iii) Equity market price risk — Economic trends, the political environment and other factors can positively or adversely impact the equity markets and consequently the value of equity investments held by the defined benefit plan. If equity market returns exceed or lag behind the discount rates, the net defined benefit obligation will be impacted.

(iv) Foreign exchange risk — Changes in foreign exchange rates will impact the fair value of foreign pooled equity funds held by the defined benefit plan. A decrease in the value of foreign currencies relative to the Canadian dollar will decrease the fair value of foreign pooled equity funds, increasing the net defined benefit obligation. An increase in the value of foreign currencies relative to the Canadian dollar will have an inverse effect.

(v) Life expectancy risk — Changes in life expectancy will impact the amount of benefits provided under post-employment benefits resulting in a change in the benefit obligation. An increase in life expectancy will increase the amount of benefits provided under post-employment benefits resulting in an increase in the benefit obligation. A decrease in the life expectancy will have an inverse effect.

18. CAPITAL MANAGEMENT

Management develops the capital strategy for the Company and supervises the capital management processes. The Board of Directors is responsible for overseeing management’s compliance with the capital management policies. As a federally regulated property and casualty insurance company, the Company’s capital position is monitored by OSFI. OSFI evaluates the Company’s capital adequacy through the Minimum Capital Test (“MCT”), which measures available capital against required risk-weighted capital. Available capital comprises total equity plus or minus adjustments prescribed by OSFI. Capital required is calculated by applying risk factors to the assets and liabilities of the Company. As at the reporting date, the Company’s MCT ratio of 285.2% significantly exceeds the minimum capital ratio of 150% required by OSFI.

Management actively monitors the MCT and the effect that external and internal actions have on the capital base of the Company. In particular, management determines the effect on capital before entering into any significant transactions to ensure that policyholders are not put at risk through the depletion of capital to unacceptable levels. The Board of Directors reviews the MCT on a quarterly basis. In accordance with regulatory requirements and the Company’s capital management policies, the Board of Directors has set internal targets at levels higher and more stringent than OSFI’s minimum requirements. Management also conducts its own risk solvency assessment on at least an annual basis and provides regular updates to its Management Risk Committee, the Risk Review Committee as well as the Board of Directors.

Reinsurance is also used to protect the Company’s capital level from large losses, including those of a catastrophic nature, which could have a detrimental impact on capital. The Company has adopted policies that specify tolerance for financial risk retention. Once the retention limits are reached, as disclosed in note 9, reinsurance is utilized to cover the excess risk.

On at least an annual basis, the Company performs stress testing, including Dynamic Capital Adequacy Testing, on the Company’s capital position to ensure that the Company has sufficient capital to withstand a number of significant adverse scenarios.

19. RATE REGULATION

In common with the P&C insurance industry in general, the Company is subject to regulation in certain jurisdictions whereby rates charged to customers for certain automobile insurance policies must be approved by the applicable regulatory body. This type of business comprises 43.6% (2014: 43.2%) of the Company’s total direct premiums written during the year. The Company is subject to three types of regulatory processes as follows:

Category Description

File and use Insurers file their rates with the regulatory authority and wait for a certain amount of time before implementing them.

File and approve Insurers file their rates with the regulatory authority and wait for approval before implementing them.

Use and file Insurers file their rates with the regulatory authority within a specified period after they are implemented.



19. RATE REGULATION (continued)

The following table outlines the jurisdictions, regulatory authorities and regulatory processes that the Company is subject to:

Jurisdiction Regulatory authority Regulatory process

Alberta Alberta Automobile Insurance Rate Board File and approve

Newfoundland and Labrador Public Utilities Board File and use or file and approve

New Brunswick New Brunswick Insurance Board File and approve

Nova Scotia Nova Scotia Utility and Review Board File and use or file and approve

Ontario Financial Services Commission of Ontario File and use or file and approve

Prince Edward Island Island Regulatory and Appeals Commission File and use

Québec Autorité des Marchés Financiers Use and file

20. COMMITMENTS AND CONTINGENCIES

Commitments

The Company’s commitments include operating lease commitments and certain non-cancellable contractual commitments. The Company’s motor vehicles, computers and office equipment are supplied through operating leases. The future contractual aggregate minimum lease payments under non-cancellable operating leases and other commitments are as follows:


Within 1 year $ 40,613 $ 37,300

Later than 1 year but not later than 5 years 55,259 56,693

Later than 5 years 13,919 19,928

Operating lease payments included in “Operating expenses” in the consolidated statement of comprehensive income during 2015 were $17.5 million (2014: $17.7 million).

Total future minimum sublease income under non-cancellable subleases amounted to $2.4 million (2014: $3.5 million).

Contingencies

In common with the insurance industry in general, the Company is subject to litigation arising in the normal course of conducting its insurance business. The Company is of the opinion that this litigation will not have a significant effect on its financial position, results of operations, or cash flows.

21. DEMUTUALIZATION

Demutualization is the process whereby a mutual company converts into a share company. On July 1, 2015, regulations were published by the federal government’s Department of Finance designed to allow federally-regulated mutual property and casualty insurance companies to demutualize. On November 3, 2015, the Company’s Board of Directors announced its decision to proceed with demutualization within the regulatory framework. At the first special meeting on demutualization held on December 14, 2015, the Company’s eligible mutual policyholders passed a special resolution to authorize the start of negotiations of the allocation of demutualization benefits with eligible non-mutual policyholders.

22. SUPPLEMENTAL EXPENSE INFORMATION

Included in “Operating expenses” and “Net claims and adjustment expenses” are the following:


Salary and benefit expenses $ 218,324 $ 190,339

Post-employment plan expenses 17 6,527 6,651

Occupancy expenses 16,585 16,953

$ 241,436 $ 213,943



23. RELATED PARTY TRANSACTIONS

From time to time, the Company enters into transactions in the normal course of business, which are measured at the exchange amounts, with certain directors, senior officers and companies with which it is related. Management has established procedures to review and approve transactions with related parties and reports annually to the Corporate Governance Committee of the Board of Directors, on the procedures followed and the results of the review.

The compensation of key management personnel, defined as the Company’s directors, president and chief executive officer and senior vice-presidents, is as follows:


Salaries $ 5,260 $ 4,456

Short-term, medium-term and long-term incentive plans 9,611 10,264

Post-employment defined benefit pension benefits 25 24

Post-employment defined contribution pension benefits 334 314

Other post-employment benefits 45 31

Other short-term employment benefits 106 124

Directors’ fees* 1,298 942

$ 16,679 $ 16,155

*Directors’ fees disclosed above include fees accrued in respect of all controlled entities in the group.

Employment benefit plans

The Company makes contributions to employment benefit plans on behalf of its employees, including both defined contribution and defined benefit plans. Information regarding transactions with the plans is included in note 17.

Associates

At the reporting date, commercial loans of $7.1 million (2014: $1.8 million) are due from companies subject to significant influence. The loans are included in “Investments” in the consolidated balance sheet and are initially measured at the exchange amount. The loans are subsequently measured in accordance with the accounting policy for loans and receivables (note 2).

The Company participates in a quota share reinsurance treaty of a company subject to significant influence under terms consistent with the other reinsurers. The Company’s share of reinsurance assumed from the associate, including reinsurance assumed contracts (note 9), is as follows:


Premiums assumed 9,16 $ 4,224 $ 3,835

Premiums earned 7,9 3,853 3,696

Claims and adjustment expenses 7,8,9 3,883 2,567

Commissions 9 1,496 1,584

Reinsurance assumed assets:


DPAE 9 $ 718 $ 665

Reinsurance assumed receivables 9 82 358

$ 800 $ 1,023

Reinsurance assumed liabilities:


UPR 9 $ 2,261 $ 1,890

Claim liabilities 9 5,851 4,055

$ 8,112 $ 5,945



24. MEDIUM-TERM INCENTIVE PLAN

Restricted units

The following table shows the outstanding units and current estimated liability pertaining to the RUs issued under the Company’s incentive plan as at December 31.

2015

Performance cycles Number of units

Liability (in thousands of

dollars)

2013-2015 77,714 $ 1,532

2014-2016 80,528 1,121

2015-2017 85,653 622

243,895 $ 3,275

2014



dollars)

2013-2015 88,014 $ 1,218

2014-2016 93,852 646

181,866 $1,864

The following table shows the movements in the RUs during the year.

2015 2014

Number of units Number of units

Outstanding, beginning of year 181,866 -

Awarded 99,928 181,866

Cancelled (37,899) -

Settled - -

Outstanding, end of year 243,895 181,866

A reconciliation of the RU liability is provided below:


Balance, beginning of year $ 1,864 $ -

Provisions made during the year 1,411 1,864

Payments made during the year - -

Balance, end of year $ 3,275 $ 1,864

Performance units

The following table shows the outstanding units and current estimated liability pertaining to the PUs issued under the Company’s incentive plan as at December 31.

2015



dollars)

2013-2015 116,572 $ 2,237

2014-2016 120,792 1,505

2015-2017 128,479 932

365,843 $ 4,674



24. MEDIUM-TERM INCENTIVE PLAN (continued)

Performance units (continued)

2014



dollars)

2013-2015 132,023 $ 1,841

2014-2016 140,779 899

272,802 $ 2,740

The following table shows the movements in the PUs during the year.

2015 2014

Number of units Number of units

Outstanding, beginning of year 272,802 -

Awarded 149,892 272,802

Cancelled (56,851) -

Settled - -

Outstanding, end of year 365,843 272,802

A reconciliation of the PU liability is provided below:


Balance, beginning of year $ 2,740 $ -

Provisions made during the year 1,934 2,740

Payments made during the year - -

Balance, end of year $ 4,674 $ 2,740

The amount charged to “Operating expenses” for the MTIP was $3.3 million for the year ended December 31, 2015 (2014: $4.6 million).

25. OPERATING SEGMENTS

The Company’s management and directors review the results of operations based on two reportable segments, the P&C insurance segment and the broker operations segment. As more than 99% (2014: 99%) of assets are included in the insurance segment, no separate segmented disclosure is required.


OUR BRANDS


BOARD OF DIRECTORS*

John H. Bowey, Chair (2, 6, 7, 8)

Elizabeth L. DelBianco (2, 3, 8)

Daniel J. Fortin (3, 5, 7, 8)

Barbara H. Fraser (2, 3, 7)

Richard M. Freeborough (1, 5, 6)

Karen L. Gavan (4)

Gerald A. Hooper (1, 4, 5)

Micheál J. Kelly (1, 2, 7) (joined as of April 1, 2015)

Charles M.W. Ormston (retired as of January 31, 2015)

Michael P. Stramaglia (1, 4, 5)

W. David Wilson (3, 4, 6)

COMMITTEES*

1. Audit

2. Corporate Governance

3. Human Resources and Compensation

4. Investment

5. Risk Review

6. Special

7. Strategic Initiatives

8. CEO Search

*As of April 1, 2016

94 2015 ANNUAL REPORT

EXECUTIVE MANAGEMENT TEAM*

Karen Gavan, FCPA, FCA, ICD.D President and Chief Executive Officer

Innes Dey, B.Sc. (Hons), LL.B Senior Vice-President and Chief Strategy Officer

Linda Goss, B.Sc. (Hons), FCIA, FCAS Senior Vice-President and Chief Actuary

Alice Keung, BA, MBA Senior Vice-President and Chief Information Officer

Elaine Lajeunesse, BActSc, CFA, FCIA, FCAS Senior Vice-President and Chief Risk Officer

Philip Mather, CA, B.Sc. (Hons) Senior Vice-President and Chief Financial Officer, President of Economical Financial

Tom Reikman, B.Sc. (Hons), MBA, CIP Senior Vice-President and Chief Operating Officer

Michael Shostak, BA (Hons), MBA Senior Vice-President and Chief Marketing Officer

Louise Taylor Green, MBA, CMC, CHRL, CHRE Senior Vice-President and Chief Human Resources Officer

Chris Van Kooten, FCIA, FCAS Senior Vice-President and Chief Underwriting Officer

*As of January 25, 2016


The combined environmental certifications associated with the paper used in this report (Classic linen, Supreme silk and Roland enviro100) are as follows:

2 0 1 5 A N N U A L R E P O R T

20

15A

NN

UA

L REP

OR

TEco

no

mical Insuran

ce

HEAD OFFICE 111 Westmount Road South P.O. Box 2000, Waterloo, ON N2J 4S4 T 519 570 8500 F 519 570 8389

e co n o m ic a l insu r a n ce .co m

Documents

Economical Insurance 2015 Annual Report imag… · 2015 ANNUAL REPORT HEAD OFFICE 111 Westmount Road South P.O. Box 2000, Waterloo, ON N2J 4S4 T 519 570 8500 F 519 570 8389 economicalinsurance.com