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The Company’s financial instruments, including investments, are exposed to interest rate risk (including the impact of credit spreads), equity market price risk and preferred stock 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. Changes in interest rates can occur from both changes in the Government of Canada yield curve and changes in relevant market credit spreads. 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 (assuming a parallel shift across the yield curve), on the FVTPL and AFS bond portfolios, with all other variables held constant is as follows:

2016 market and Stock Price Risk
(in thousands of dollars) 2016 2015
Impact on: +1% -1% +1% -1%
Fair value of FVTPL bonds and income before income taxes $ Loss: (64,778) $ 72,889 $ Loss: (67,034) $ 74,243
Fair value of AFS bonds and OCI before income taxes $ Loss: (63,770) $ 78,755 $ Loss: (62,264) $ 75,140

The estimated impact on income taxes would be calculated at the statutory rate of 26.71% (2015: 26.71%).

(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. Economic trends, interest rates, credit conditions, regulatory changes and other factors can positively or adversely impact the value of preferred stocks that the Company holds. The fair value sensitivity of the Company’s preferred stocks are assessed against movements in the BMO 50 Resets Sub-Index

The estimated impact of a 10% movement in the aforementioned indices to the value of the Company’s equity portfolios, 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:

2016 Market and Stock Price Risk
(in thousands of dollars) 2016 2015
Impact on: +10% -10% +10% -10%
Fair value of Canadian stocks and OCI before income taxes $ 46,490 $ Loss: (46,490) $ 34,880 $ Loss: (34,880)
Fair value of foreign stocks, pooled funds and OCI before income taxes $ 25,544 $ Loss: (25,544) $ 24,705 $ Loss: (24,705)
Fair value of preferred stocks and OCI before income taxes $ 31,117 $ Loss: (31,117) $ 26,989 $ Loss: (26,989)

The estimated impact on income taxes would be calculated at the statutory rate of 26.71% (2015: 26.71%).

(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. The Company’s principal approach to mitigate credit risk is to maintain high credit quality standards and to diversify credit exposures by limiting single name concentrations. Concentration risk also exists where multiple counterparties may be financially affected by changing economic conditions in a similar manner. As noted below, the Company has a concentration of investments in Canada and within the financial sector. These risk concentrations are regularly monitored and adjusted as deemed necessary.

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, 2016, 92.3% (2015: 92.0%) were rated “A-” or better and 85.4% (2015: 88.1%) 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, 66.3% (2015: 75.0%) are concentrated in the financial services industry, 8.9% (2015: 8.1%) are concentrated in industrial, 6.6% (2015: nil) are concentrated in utilities, 6.1% (2015: 4.5%) are concentrated in communications, and 12.1% (2015: 12.4%) are in other industries. Of the preferred stocks and bonds held, the country of issuer is concentrated as 90.5% (2015: 90.8%) in Canada, 5.9% (2015: 5.5%) in the US and 3.6% (2015: 3.7%) 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, 2016 is 103.3% (2015: 103.0%).

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, principally in the form of security over a borrowing brokerage’s operating assets, is held to protect the Company against loss in the event of a default of any of these loans. Annual, and where required more frequent, financial reviews are undertaken to determine if the broker will be able to make the payments required by the loan as and when due. The Company’s gross credit exposure on these commercial loans is limited to their carrying value as disclosed in note 5. Management does not consider any of these current commercial loans to be impaired as at December 31, 2016.

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 (2015: $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 fulfil 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, 2016, 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 $287.5 million (2015: $271.9 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 largest 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 $14.0 million (2015: $11.2 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 $4.0 million (2015: $6.1 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% (2015: 26.71%).

(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, 2016, the Company has $189.6 million (2015: $89.0 million) of cash and cash equivalents and short-term investments of nil (2015: $27.0 million). The Company also has a highly liquid investment portfolio. As at December 31, 2016, 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 $3,774.1 million (2015: $3,944.2 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.

2016 Liquidity Risk
(in thousands of dollars) 2016
  Less than 1 year 1-5 years 6-10 years 10 years + Total
Cash and cash equivalents $ 189,553 $ $ $ $ 189,553
FVTPL bonds   57,363   666,538   808,799     1,532,700
AFS bonds   58,750   447,056   468,943   188,680   1,163,429
Preferred stocks   100,565   253,328   24,055     377,948
Commercial loans   4,822   40,349   39,917     85,088
Accrued investment income   14,597         14,597
Premiums receivable   644,685   3,337       648,022
Income taxes receivable   45,913         45,913
Reinsurance receivable and recoverable   53,413   33,693   6,990   981   95,077
  $ 1,169,661 $ 1,444,301 $ 1,348,704 $ 189,661 $ 4,152,327
Claim liabilities $ 698,036 $ 1,091,076 $ 390,265 $ 115,142 $ 2,294,519
Accounts payable and other liabilities   146,035   7,437   9,519   37,987   200,978
  $ 844,071 $ 1,098,513 $ 399,784 $ 153,129 $ 2,495,497
2015 Liquidity Risk
(in thousands of dollars) 2015
  Less than 1 year 1-5 years 6-10 years 10 years + Total
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
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

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.