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5. INVESTMENTS

(a) Investment income and balances

Investment income by financial instrument classification is as follows:

2016 Investment Income by Financial Instrument
(in thousands of dollars) 2016
  Notes FVTPL AFS Loans and receivables Total
Interest   $ 25,120 $ 34,762 $ 1,261 $ 61,143
Dividends       39,177     39,177
Realized gains on sale of investments     14,330   54,047     68,377
Net impairment losses on AFS investments 5(c)     Loss: (6,317)     Loss: (6,317)
Unrealized losses on FVTPL financial instruments     Loss: (26,987)       Loss: (26,987)
Recognized (losses) gains on investments     Loss: (12,657)   47,730     35,073
    $ 12,463 $ 121,669 $ 1,261 $ 135,393
2015 Investment Income and Balances
(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)     Loss: (19,729)     Loss: (19,729)
Unrealized losses on FVTPL financial instruments     Loss: (8,962)       Loss: (8,962)
Recognized gains on investments     27,739   46,142     73,881
    $ 64,162 $ 114,881 $ 408 $ 179,451

The fair value yield as at December 31, 2016 for the FVTPL bond portfolio was 1.67% (2015: 1.34%) and for the AFS bond portfolio was 2.71% (2015: 2.53%).

Investment carrying values by financial instrument classification are as follows:

2016 Investment Carrying Values
(in thousands of dollars) 2016
  FVTPL AFS Loans and receivables Total
Bonds $ 1,532,700 $ 1,163,429 $ $ 2,696,129
Preferred stocks     377,948     377,948
Common stocks     639,187     639,187
Pooled funds     116,148     116,148
Commercial loans       85,088   85,088
  $ 1,532,700 $ 2,296,712 $ 85,088 $ 3,914,500
2015 Investment Carrying Values
(in thousands of dollars) 2015
  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

The commercial loans have an amortized cost of $85.1 million (2015: $25.0 million) and fair value of $74.6 million (2015:  $22.8 million).

The gross 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.

2016 Gross Unrealized Gains (losses)
(in thousands of dollars) 2016
  Cost/amortized
cost
Gross unrealized
gains
Gross unrealized
losses
Fair value
Bonds:
Government $ 234,878 $ 2,542 $ Loss: (2,065) $ 235,355
Corporate   926,583   10,096   Loss: (8,605)   928,074
    1,161,461   12,638   Loss: (10,670)   1,163,429
Canadian preferred stocks   435,503   4,055   Loss: (61,610)   377,948
Common stocks:
Canadian   430,670   73,581   Loss: (1,189)   503,062
Foreign   82,305   54,869   Loss: (1,049)   136,125
Foreign pooled funds   113,859   2,289     116,148  
    626,834   130,739   Loss: (2,238)   755,335
  $ 2,223,798 $ 147,432 $ Loss: (74,518) $ 2,296,712
2016 Gross Unrealized Gains (losses)
(in thousands of dollars) 2015
  Cost/amortized
cost
Gross unrealized
gains
Gross unrealized
losses
Fair value
Short-term investments $ 26,952 $ $ $ 26,952
Bonds:
Government   354,082   5,659   Loss: (716)   359,025
Corporate   829,085   14,558   Loss: (3,631)   840,012
    1,183,167   20,217   Loss: (4,347)   1,199,037
Canadian preferred stocks   433,634   3,343   Loss: (66,413)   370,564
Common stocks:
Canadian   417,092   22,340   Loss: (14,063)   425,369
Foreign   79,100   53,908   Loss: (175)   132,833
Foreign pooled funds   113,963   257     114,220
    610,155   76,505   Loss: (14,238)   672,422
  $ 2,253,908 $ 100,065 $ Loss: (84,998) $ 2,268,975

(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.
  • (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, 2016, the Company has no financial instruments in this category (2015: 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:

2016 Distribution of Financial Instruments
(in thousands of dollars) 2016
  Level 1 Level 2 Level 3 Total
Bonds $ $ 2,696,129 $ $ 2,696,129
Preferred stocks   377,948       377,948
Common stocks   639,187       639,187
Pooled funds     116,148     116,148
  $ 1,017,135 $ 2,812,277 $ $ 3,829,412
2015 Distribution of Financial Instruments
(in thousands of dollars) 2015
  Level 1 Level 2 Level 3 Total
Short-term investments $ $ 26,952 $ $ 26,952
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

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

(c) Impairment review

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

2016 Impairment reclassification of unrealized losses from AOCI to net (loss) income
(in thousands of dollars) 2016 2015
Common stocks:
Canadian $ 6,149 $ 19,113
Foreign   168   616
  $ 6,317 $ 19,729

The remaining gross unrealized losses of $74.5 million (2015: $85.0 million) on the AFS investments have not been recognized in net (loss) 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, 2016, securities with an estimated fair value of $527.3 million (2015: $509.3 million) have been loaned and securities with an estimated fair value of $545.0 million (2015: $524.6 million) have been received as collateral from the financial institutions. Lending collateral as at December 31, 2016 was 100.0% (2015: 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 material embedded derivatives were identified that required bifurcation.