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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 next step in the demutualization process is for the court-appointed policyholder committees to negotiate the allocation of financial benefits, after which our demutualization will require a series of distinct approvals, including from our primary regulator, two policyholder votes and the federal government.

PERSONAL AUTO ENVIRONMENT

Ontario

The 2015 Ontario budget contained a number of reforms to Ontario automobile insurance intended to reduce fraud and claims costs in the system, and reduce the premiums paid by consumers. A number of changes took effect in June 2016, the impacts of which will be realized gradually over 24 months in our underwriting performance. Significant changes address the definition of catastrophic injury, along with the cost of medical, rehabilitation and attendant care benefits. In anticipation of the cost reductions, the Financial Services Commission of Ontario mandated additional rate reductions coincident with the legislated changes in coverage, and there are other minor changes that impact revenues for insurers. The budget measures did not offset the rate reductions or increase the overall profitability of Ontario personal auto.

We continue to see deterioration in the current definition of catastrophic injury and increasing medical claims severity since 2014 when the recent budget changes were first conceived. There is a significant risk that future medical costs could be higher than expected if the 2016 reforms are not implemented appropriately, or that the reforms may not be sufficient in light of changes in the market. The Ontario personal auto market is very dynamic from many perspectives — political, regulatory, and consumer. We continue to actively participate in industry and government consultation and respond appropriately.

Alberta

Insurers operating in Alberta continue to experience increases in claim costs relating to automobile bodily injury claims. Like Ontario, persons injured in motor vehicle accidents in Alberta by a third party can only sue for damages for injuries that are considered non-minor. Recent court decisions have limited the scope of the Minor Injury definition, thereby increasing the number of claims reported under the bodily injury liability coverage and thereby increasing the claim costs for this coverage as well as greater occurrence of pain and suffering awards. In addition, as claims take longer to settle in the courts, there are higher awards for prejudgment interest. These trends are increasing claim costs on bodily injury claims and putting pressure on profitability in this line of business.

British Columbia

For the past several years, we have seen deterioration in the British Columbia personal automobile environment. Insurers operating in this province face strong competition with the Insurance Corporation of British Columbia (“ICBC”), which is a government run monopoly. Insurers are only permitted to offer optional automobile coverages, most notable of which is third-party liability coverages, which provides coverage in excess of the basic $200,000 coverage provided by ICBC.

British Columbia is a full tort legal environment, and claims costs in the province have been escalating due to a larger frequency of liability claims and increasing court awards. The trends in loss costs are significant for ICBC who cover all liability claims from the ground up, but for insurers who cover losses in excess of the $200,000 minimum, the loss trends are even greater as they pay the full increase of costs over the limit on the policies that they write. The British Columbia government is putting pressure on ICBC to cap premium increases but the increase in claims costs must be controlled to do so. We continue to implement corrective actions to address the deterioration on the auto excess liability product while monitoring and assessing the political pressures on this issue in the province.

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 we, along with the P&C industry in Canada as a whole, endured what was then the worst catastrophe loss year in its history. We have since been heavily impacted by significant catastrophic activity in 2016, primarily related to the Fort McMurray wildfire in Alberta (the largest insured loss in Canadian history) and numerous hail storms in Alberta. Weather events are expected to continue to create increased volatility in results, particularly in our property lines of business. We manage our catastrophe events exposure by managing the geographic concentration of policy exposures, purchasing reinsurance, the use of our policy deductibles, and monitoring the impact on capital position and overall risk tolerances.

CAPITAL MARKETS

Heightened global growth concerns impacted financial markets in early 2016. These concerns were intensified following the United Kingdom vote to leave the European Union (“Brexit”) at its June 23 referendum, an event which triggered a substantial sell-off in equities and a rally in bond markets. Risk assets quickly recovered from their post-Brexit losses at the beginning of the third quarter of 2016, as the economy of the United Kingdom proved resilient to the uncertainty surrounding its planned departure from the Eurozone. The equity rally strengthened following the November presidential election in the United States. After a one-year pause, the Federal Reserve increased its benchmark rate by 25 basis points at its December 14, 2016 meeting, while citing solid job gains and higher market-based measures of inflation. Overall, the political environment in the United States is highly uncertain and the impact on fiscal and monetary policy is unclear. Meanwhile, the Bank of Canada has kept its benchmark rate unchanged since July 2015 and is not expected to raise interest rates until 2018.

We continue to manage the risk and volatility inherent in capital markets by focusing on long-term value creation through investing in high quality fixed income and equity securities, while maintaining an optimal asset allocation aimed at maximizing returns within acceptable risk parameters.

INDUSTRY CONSOLIDATION

Merger and acquisition activity in the global and Canadian P&C industry continues to be very active. Consolidation in the Canadian marketplace is expected to continue at all levels. While the industry remains highly fragmented relative to other financial service sectors in Canada, P&C premiums are becoming increasingly concentrated within the industry’s largest companies. Conditions remain favourable for further consolidation, including competitive market pressures, low investment returns, and the global regulatory environment. The primary rationale for further consolidation in the P&C industry is to add scale, the benefits of which include operational and underwriting efficiencies. Acquisitions may also achieve additional objectives, including expansion of operational capabilities, geographic diversification, and access to additional distribution channels with the goal of optimizing growth and meeting customer demands. Changing demographics and pressure to increase market share is also fuelling the consolidation in the Broker Market landscape. Inorganic growth is a key component of our overall growth strategy, as demonstrated by our recent acquisition of Western Financial Insurance Company. Our plan to pursue demutualization is expected to provide us with additional access to capital to support our strategic initiatives, including funding future acquisitions of a scale beyond our current means as a mutual company. We are also making significant investments in people, infrastructure, and operations, which will strengthen our ability to execute and integrate acquisitions.

CONSUMER BEHAVIOURS AND PRODUCT CHANGE

Consumer demographics and behaviours continue to evolve. Digital technologies are increasing the expectations from consumers for a more personalized experience from their insurance providers. Building additional distribution channels is becoming increasingly important in order to reach this 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 address this significant segment of the market, we have expanded our distribution strategy in 2016 with the launch of our digital direct brand, Sonnet, which offers personal property and auto insurance.

Changing consumer behaviours and climate change are also having an impact on product design. Insurers are designing products to address new and emerging risks. In particular, the increased occurrence of overland flood events in Canada in recent years has increased attention on the availability of overland flood insurance. In response to these events, we launched an overland flood personal property product in 2016. The growth in the sharing economy, and changing consumer demographics and behaviours have also impacted product offerings, resulting in the introduction of insurance products in the market for cyber risk, ridesharing, and drones, as well as 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 in the longer term.

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