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

Transcription

1

2 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. where we are going We want to be the insurance partner Canadians choose to protect what they value most. Our vision is to be one of Canada s top P&C insurers, recognized by our customers, broker partners, and employees for our innovative approach to business, and how well we take care of our customers. customer satisfaction * CLAIMS EXCELLENCE Over 73,000 surveyed since 2007 After filing a claim, 92% of Economical policyholders indicated that they are satisfied or very satisfied with the quality of their claims service experience, based on a response rate of 29%*. This clearly shows that we are consistently delivering superior claims adjudication and service, the very essence of why we re in business. * Percentage based on 73,244 Economical claimant survey responses measuring customer satisfaction with Economical s claims services from January 2007 to December On May 1, 2015, A.M. Best affrmed the financial strength rating of A- (Excellent) and issuer credit ratings of a- for Economical Mutual Insurance Company and its wholly owned subsidiary, Waterloo Insurance Company. The outlook for all ratings is stable. This recognizes Economical s excellent financial strength and strong operating performance. It also reinforces the confidence of our customers and our 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 nationally.

3 2014 performance at a glance GROSS WRITTEN PREMIUMS (GWP) ($ BILLIONS) With a focus on profitable growth, Economical continued to increase its GWP levels since For 2014, GWP grew by $43.8 million or 2.3% compared to the prior year EXPENSE RATIO We completed our Business Transformation Program in 2014, an investment which has improved the effciency and effectiveness of our operating platform, positioning us for future growth and sustained cost containment % 34.5% 34.8% 32.9% 32.7% * * 2012 restated for Pension Adjustment impact of 0.1 percentage points. COMBINED RATIO (COR) Despite a reduction in weather-related catastrophe losses from the record levels set in 2013, Economical experienced a challenging year in Our COR for the year was 102.1%, up marginally from 2013 due to lower levels of favourable prior years loss reserve development and an overall increase in the frequency of claims, partly due to the impact of severe winter weather in the first quarter % 98.1% 96.5% 100.1% 102.1% NET INCOME ($ MILLIONS) Net income for 2014 was stable at $84.2 million, supported by an overall increase in investment income for the year * * 2012 restated for Pension Adjustment impact of 0.1 percentage points * 2013 * 2012 restated for Pension Adjustment impact of $1.7 million TOTAL EQUITY ($ BILLIONS) Economical s book value continued its upward momentum in 2014, increasing 6.9%. Our total equity is now the strongest in Economical s 143-year history MINIMUM CAPITAL TEST (MCT) MCT is a regulatory formula that is a risk-based test of capital available relative to capital required. For the last three years, our MCT has exceeded 295%, significantly in excess of the regulatory minimum of 150% % 295.1% 295.2% 295.4% %

4 a message from Gerry Hooper, chairman of the board There are rare moments that shape the destiny of a company, let alone an industry. One of those moments is almost upon us a moment that has the potential to open new doors for Economical. We have important contributions to make in strengthening Canada s property and casualty insurance industry in the future, providing Canadian consumers and businesses with choice in an industry that is increasingly consolidating. In the four years that draft demutualization regulations have been under development, there have been eight major transactions involving the Top 10 participants in our industry. The big are getting bigger. Large companies are acquiring smaller competitors and gaining market share and economies of scale. We have not been standing still. Over that same period, Economical has made tremendous progress growing the business profitably and securing our financial strength, despite the impacts of recent weather-related events that are becoming more frequent. To compete on an equal footing with the leading Canadian and foreign-owned companies in our market, we are investing heavily in our long-term competitiveness and establishing an integration platform for future acquisitions. However, achieving our vision of industry leadership depends on meaningful participation in the ongoing consolidation of our industry. With access to the capital markets that many of our competitors already enjoy, we would increase our financial flexibility, our agility, and our long-term strength. Through a successful demutualization, we will be on a level playing field with our larger competitors. In February, we were pleased to see the Department of Finance s process progress with the release of draft regulations to guide the demutualization of P&C companies. The framework reflected in the draft regulations sets out a long and complex process, one that if implemented in the 2

5 final regulations, will require patience, perseverance, and pragmatism to complete. Once final demutualization regulations have been implemented, the board will carefully reflect on the final framework and determine whether demutualization is still in the best interests of Economical. Our industry is facing significant challenges. In recent years, the frequency of major catastrophe losses has been increasing due to the severe impacts of climate change, particularly floods. The industry will continue to be affected by the scale and frequency of weather-related events, as well as government involvement in Ontario auto costs. Despite these challenges, we finished 2014 with a net income of $84.2 million, and increased our total equity by $108.0 million to nearly $1.7 billion. This demonstrates our resiliency and financial strength through both hard and soft markets. Economical s vision is clear: to be one of Canada s top P&C insurers recognized for our business innovation and how well we take care of our customers. Thanks to strong leadership, a strategic business model, and the dedicated team of employees, we will reach this goal. The company has achieved an industry-leading sophistication in the application of predictive analytics, pricing, and risk management. We will continue to focus on improving profitability in our commercial property and liability business through targeted rate increases based on risk pricing. We are excited about the potential of this change, and are building off the momentum of another successful change that was the largest in Economical s history. We recently completed transformation of our underwriting operations, which has proven to be a great success. It is already delivering benefits through improved productivity, effciency, and operating effectiveness. We are now primed for future growth and sustained cost containment in a rapidly changing marketplace. We continue to strengthen our board as part of our ongoing renewal process. In October, I had the pleasure of welcoming Dan Fortin, immediate past president of IBM Canada Ltd., to the board, and in April welcomed Dr. Micheál Kelly, Dean of Laurier s School of Business and Economics, as new directors. We are looking forward to benefiting from their considerable experience and expertise to support Economical s future growth and to help build sustainable competitive advantage. We were sorry to see Charles Ormston retire from the board after 20 years of dedicated service. I want to personally thank Charlie for the insight and dedication he brought to help guide Economical through tremendous growth over the past two decades. We will miss his wise counsel and wish him well. As a Board, we are confident that we have the right leadership, strategy, and people in place to ensure Economical continues to elevate our service excellence on all fronts and for all stakeholders. I want to acknowledge the trust, loyalty and confidence that our broker partners continue to express in Economical. I particularly want to recognize the talent, commitment, and motivation of Economical employees to achieve our goals. Thank you for your unwavering dedication. Sincerely, GERRY HOOPER Chairman of the Board Economical has made tremendous progress growing the business profitably and securing our financial strength...to compete on an equal footing with the leading Canadian and foreign-owned companies in our market, we are investing heavily in our long-term competitiveness and establishing an integration platform for future acquisitions. 3

6 a message from Karen Gavan, president and ceo These are exciting times at Economical. Canada s property and casualty insurance industry is going through tremendous change that offers great opportunities for us. We are poised to unlock the tremendous growth potential we see ahead, and we ll do this by continuing to raise the bar. We have come a long way since our humble beginnings in Our refreshed values echo the foundation upon which our success was built: We focus on customers first. We bring our best. We are stronger together. Our financial strength today is a testament to those values. Coupled with the diligence and professionalism of our employees and broker partners, our company successfully navigated the volatility of With a deliberate focus on profitable growth, we have grown our top line in gross written premiums by 13.9% since In 2014, our top line rose by $43.8 million (or 2.3%) compared to the prior year. We ended the year with a combined operating ratio of 102.1%, up marginally from This was impacted by lower levels of loss reserve development from prior years, and an overall increase in the frequency of claims partly reflecting the severe winter weather in the first quarter. Net income for 2014 was $84.2 million, supported by an overall increase in investment income of $59.2 million. Total equity grew to a new record level, reaching nearly $1.7 billion by the end of the year. Our MCT ratio is in excess of 295%, further demonstrating the strength of our financial position. We can all take pride in these results. They were achieved because of our relentless focus on the customer, our dedication to bringing our best to the table, and our commitment to teamwork. Business innovation is a key focus for Economical as we compete for the top spot in the marketplace. By creating a focused strategy around data collection and analysis, we are enhancing predictive analytics to continually improve our pricing sophistication. By leveraging predictive analytics, claims data, and underwriting expertise, we will be able to offer pricing based on rating variables specific to individual risk, introduce strategic and targeted pricing, and encourage 4

7 brokers to place desirable and profitable business with us. Over the past eight years, we have consistently delivered superior claims service with a 92% customer satisfaction rating. Exceeding customer expectations has become especially important in an environment that is increasingly demanding. The combination of mandatory rate reductions and ongoing claims inflation in Ontario offers both challenges and opportunities for Economical. We will maintain our focus in this critically important region to meet these challenges with innovative solutions. At the same time, we continue to invest in improving the effciency and effectiveness of our operating platform. During the year, we completed our multi-year business transformation program the largest in our history which focused on improving the agility and consistency of our underwriting operations across the country. It is remarkable how we were able to fundamentally shift our business model in a very short time frame. The cornerstone of that model is our new national processing centre in Kitchener, which has improved our productivity, increased effciency, and positioned us for future growth. We have also begun a significant multi-year investment in a state-of-the-art policy administration and billing system that will allow us to deliver products and services to market in a more competitive and effcient manner, while making it easier to do business with us. This new architecture is strategically designed to keep our eyes focused on the future, providing technology that will support and evolve with our business also brought new strength to our senior management team with a number of key appointments. The entire leadership team is collaborating on a bold integrated strategy to move toward an industry-leading business model. One of the most important initiatives we started in 2014 was to reimagine our corporate vision, mission, and values. We know that investing in our people will build a team that will make Economical one of Canada s top P&C insurers, recognized for our business innovation and how well we take care of our customers. Creating a culture that encourages innovation and teamwork is critical to our long-term success, and will remain a strategic priority in the years ahead. And our efforts continue to be acknowledged. In 2014, we were recognized by World Finance magazine for the second consecutive year as the best general insurer in Canada. This award acknowledges our commitment to transforming our business operations and IT services, implementing best practices, and for our world-class training and development program. We also maintained our rating of A- (Excellent) by independent rating agency A.M. Best, which reflects our excellent financial strength and performance. This reinforces our broker partners confidence in recommending Economical to their commercial and group insurance customers. We are proud of our 143-year heritage and the deep roots we have in the communities we serve. In recent years, we have experienced rapid change in our industry to meet the needs of increasingly savvy customers. Change has become a constant in the way we do business and we have learned to be fast, flexible, and ready for whatever comes our way. I am truly amazed at what we ve accomplished so far. The expertise and dedication of our employees have brought Economical to where it is today a strong, competitive, agile company that is ready to take the next leap forward. Thank you to the leadership team for living our core values and helping instill a sense of pride in the work we do every day. Trust and loyalty are earned through the value we deliver to our broker partners and customers. We are committed to providing this value through service excellence and together, we will achieve our goal of becoming one of Canada s top P&C insurers. Sincerely, KAREN GAVAN President and chief executive offcer...we have grown our top line in gross written premiums by 13.9% since Total equity grew to a new record level, reaching nearly $1.7 billion by the end of the year. Our MCT ratio is in excess of 295%, further demonstrating the strength of our financial position. 5

8 6

9 management s discussion and analysis table of contents Introduction 8 Section 1 Corporate overview 9 Section 2 Financial performance 11 Section 3 Results by line of business 15 Section 4 Business developments and operating environment 18 Section 5 Canadian P&C industry outlook 19 Section 6 Financial condition 21 Section 7 Liquidity and capital resources 26 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 43 Section 14 Definitions 44 7

10 MANAGEMENT S DISCUSSION AND ANALYSIS introduction May 15, 2015 The following Management s Discussion and Analysis ( MD&A ) is the responsibility of management and has been approved by the Board of Directors (the Board ). This MD&A is intended to enable the reader to assess our financial condition and our results of operations as at and for the year ended December 31, 2014, as compared to our year ended December 31, 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, Unless otherwise noted in this MD&A, all information is given as at May 15, 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, as issued by the International Accounting Standards Board, which has 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. The Company s 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 the Company s 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; management s ability to accurately predict future claims frequency or severity including the frequency and severity of weatherrelated 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 the Company s 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 meet payment obligations as they become due; the risk of financial loss from an inadequate enterprise risk management framework; Economical s reliance on information technology and telecommunications systems; changes in government regulations; litigation and regulatory actions; periodic negative publicity regarding the insurance industry; 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. 8

11 MANAGEMENT S DISCUSSION AND ANALYSIS section 1 corporate overview ABOUT ECONOMICAL INSURANCE Founded in 1871, Economical Insurance is one of Canada s leading property and casualty ( P&C ) insurers. Economical Insurance conducts business under the following brands: Economical Insurance, Economical, Western General, Economical Select, Perth Insurance, Family Insurance Solutions, Federation Insurance and Economical Financial. A Canadian mutual insurance company, Economical provides a wide range of personal and commercial insurance products to customers in most provinces and territories across Canada. Economical competes against Canadian and foreign owned stock-based companies and mutual companies. Economical s head offce is located in Waterloo, Ontario, with branches and service offces across the country providing service to policyholders and brokers. Economical partners with independent insurance brokers who work with customers to assess their insurance needs and choose the right products and coverage. Economical is committed to providing its broker partners and policyholders with the products and services that today s market demands. The financial stability of Economical is demonstrated by assets over $5.2 billion and total equity approximating $1.7 billion as at December 31, 2014, reflecting the combined strength of its member companies. CORPORATE STRATEGY Our vision, mission and values form the foundation of our strategy. They drive alignment throughout the Company to ensure our people are working together collectively to achieve our desired results. Our vision is to be one of Canada s top P&C insurers, recognized for our business innovation and how well we take care of our customers. Our mission is to be the insurance partner Canadians choose to protect what they value most. We will achieve our vision and mission through our core values: we focus on customers first, we bring our best, and we're stronger together. Our near term priorities to operationalize our strategy are to: Drive profitable growth We continue to enhance our already strong predictive analytics and underwriting sophistication through ongoing investments in industry leading tools and models, including real time analytics engines. Continued leveraging of our analytics capability will improve customer focus, targeting, risk classification, pricing, product design and business mix optimization. Combining our competitive advantage in pricing segmentation and optimization with the investment we are making in a leading technology platform to replace our internally built policy administration system ( PAS ), will significantly enhance product flexibility and speed to market, while supporting attractive, manageable growth. During 2014, we focused on pricing and product enhancements in certain areas of commercial property and liability, which will result in targeted rate increases and product changes in a number of unprofitable territories and product lines. New midmarket rating models designed to further improve profitability at the product level are being developed, and are expected to be implemented over the next several quarters. While we expect the improvements we are making will return the commercial property and liability lines to profitability, the impact of our actions will not be immediately realized as rate increases and product changes take time to implement and earn through the book of business. Continue to improve operational effciency Commencing in 2012, we initiated a Business Transformation Program ( BTP ) to improve the effectiveness and effciency of our operations. We completed this program in As part of this initiative, the information technology department streamlined numerous functions and processes to improve effciency and provide value to the business. Certain branch locations were consolidated to utilize our space in a more effcient manner. Underwriting operations were streamlined and automated, culminating in the launch of the national and regional processing centres in August. The benefits from these operational effciencies will continue to be realized in 2015 and future years. In July 2014, we announced that we are making a significant investment to replace our internally built PAS to improve productivity and our ability to deliver products and services to market in a competitive and effcient manner. In addition, we are modernizing our information technology infrastructure with leading edge technology and industry leading best practices. The main focus of the modernization is around the data centre, mainframe and managed security services. We will continue to seek opportunities for improvement in our operational effciencies. 9

12 MANAGEMENT S DISCUSSION AND ANALYSIS Gain scale through inorganic growth Demutualization is the process whereby a mutual company converts into a share company. On February 28, 2015, draft regulations were released by the federal government's Department of Finance designed to allow federally regulated mutual property and casualty insurance companies to demutualize. The draft regulations were subject to a public comment period that ended on March 30, Once the draft regulations are finalized and in force, our Board of Directors will determine whether it is in the best interest of the Company to proceed with demutualization under the regulatory framework. The industry continues to experience consolidation. During 2014, in alignment with our strategic growth objectives, we focused on building out the newly created corporate development team. The focus of the team is to evaluate and execute on acquisition opportunities, strategic partnerships and develop and manage key stakeholder relationships. SENIOR LEADERSHIP TEAM During the last 12 months, we have continued to strengthen our executive leadership team, in particular enhancing our operations, corporate development, finance, marketing, underwriting and human resource functions. These enhancements have strengthened our core operations and have better positioned us for the future. 10

13 MANAGEMENT S DISCUSSION AND ANALYSIS section 2 financial performance FINANCIAL HIGHLIGHTS FOR THE YEAR Increased gross written premiums by 2.3% compared to 2013 Recorded a combined ratio of 102.1% Generated net income of $84.2 million Increased total equity by $108.0 million to a record $1.68 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) Policies in force 1 (thousands) Gross written premiums , , ,135.6 $ Change 32.3 % Change 2.8% 1, % Net premiums written 1 1, , % Net premiums earned Net claims and adjustment expenses, undiscounted 1, ,769.2 Other underwriting expenses % 1, , % % Underwriting loss before the impact of discounting (38.4) (2.3) (36.1) % Impact of change in net claims discount rate (16.0) 8.4 (24.4) (290.5%) Underwriting (loss) income (54.4) Investment income Other (expense) income (3.6) Restructuring expenses (1.3) (23.4) 6.1 (60.5) (991.8%) % 23.0 (26.6) (115.7%) 22.1 (94.4%) Income before income taxes (5.8) (5.2%) Income tax expense (2.3) (10.0%) Net income (3.5) (4.0%) Claims ratio % 67.2% 2.2 pts Expense ratio % 32.9% (0.2) pts Combined ratio % 100.1% 2.0 pts Return on equity 1 5.4% 6.0% (0.6) pts MCT % 295.2% 0.2 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. GROSS WRITTEN PREMIUMS AND POLICIES IN FORCE We continue to generate growth in both gross written premiums ( GWP ) and policies in force ( PIF ), which increased by 2.3% and 2.8% respectively over the prior year. Substantially all of the growth occurred in personal lines. In commercial lines, GWP levels were impacted by declines in PIF due to the non-renewal of certain non-core fronting arrangements and the exit of unprofitable lines of business. This was offset by increases in average written premiums as we began to implement targeted rate increases in certain unprofitable products and regions. Average written premiums in commercial lines were also positively impacted by changes in product mix, particularly in commercial auto where we increased our focus on larger fleet polices. Our focus remains one of profitable growth and, as such, we focus on discipline in our 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. 11

14 MANAGEMENT S DISCUSSION AND ANALYSIS NET PREMIUMS WRITTEN AND NET PREMIUMS EARNED Net premiums written increased 4.1% in 2014, outpacing GWP growth as we did not renew certain non-core fronting arrangements. Net premiums earned increased by 4.3% in 2014 reflecting the higher levels of growth throughout 2013 now earning through. 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 Change (in millions of dollars, except as otherwise noted) $ Ratio $ Ratio $ Ratio Core accident year claims 1, % 1, % pts Catastrophe losses % % (56.7) (3.3) pts Prior year favourable claims development (2.9) (0.2%) (63.0) (3.6%) pts Total 1, % 1, % pts The core accident year claims ratio, which excludes catastrophe losses and prior year claims development, increased to 67.1% in 2014 from 65.0% in While net incurred large losses (those losses greater than $1 million) decreased from $96.6 million in 2013 to $80.2 million in 2014, this decrease was more than offset by increases in the frequency of smaller claims, which were impacted by the unusually harsh winter during the first quarter of 2014 and persistent smaller weather-related events throughout the year. Net weather-related catastrophe losses decreased to more normal levels of $46.7 million in 2014 from $103.4 million in 2013, which was the largest year on record for catastrophe losses for Economical and the Canadian P&C industry. In 2014, we incurred losses in nine catastrophe events, including a January deep freeze mainly in Ontario and a hail, wind and rain storm in central Alberta in August. In 2013 we incurred losses in eight catastrophe events, led by flood events in Ontario and Alberta. We continue to invest in advanced analytics to drive price, product and risk segmentation designed to mitigate the impact of climate change. Favourable claims development in 2014 was $2.9 million compared to $63.0 million in 2013, marking nine calendar years of favourable development from prior year claims and demonstrating our continued prudent reserving practices. Refer to Figure 16, which shows the level of favourable claims development over the past nine calendar years. OTHER UNDERWRITING EXPENSES Figure 3 shows the key components of our reported expense ratio for the year ended December 31. FIGURE Change (in millions of dollars, except as otherwise noted) $ Ratio $ Ratio $ Ratio Net commissions % % 8.2 (0.4) pts Operating expenses % % Premium taxes % % Total % % pts 2.0 (0.1) pts (0.2) pts The expense ratio decreased 0.2 percentage points over the prior year to 32.7% (2013: 32.9%). The commissions ratio decreased slightly by 0.4 percentage points to 19.3%. We continue to evaluate commissions structures, better aligning commissions paid with the underlying performance of the book of business. The operating expenses ratio increased by 0.3 percentage points to 9.9%, or $9.3 million in The completion of the BTP reduced the run rate of ongoing operating expenses, but was more than offset by the cost of the BTP, new investments in the planning stages of the PAS replacement program, and costs associated with the ongoing upgrade of our information technology infrastructure. We expect that these new core infrastructure initiatives will increase operating expenses during the implementation phases, but result in substantial operating improvements thereafter. 12

15 MANAGEMENT S DISCUSSION AND ANALYSIS UNDERWRITING RESULTS Figure 4 summarizes the composition of the undiscounted and discounted combined ratio for the year ended December 31. FIGURE Change (in millions of dollars, except as otherwise noted) $ Ratio $ Ratio $ Ratio Claims ratio Expense ratio % 1, % 1, % pts % 19.5 (0.2) pts Combined ratio, undiscounted 1, % 1, % pts Impact of discounting Combined ratio, discounted % (8.4) (0.5%) pts 1, % 1, % pts An increase in claims frequency and lower levels of favourable claims development produced downward pressure on underwriting results, despite a significant reduction in catastrophe losses and large loss activity. Personal lines and commercial auto produced a total underwriting profit of $44.0 million, whereas commercial property and liability produced an underwriting loss of $82.4 million resulting in an overall combined ratio for 2014 of 102.1% (2013: 100.1%). Refer to Section 3 Results by line of business for additional details. The impact of the new core infrastructure initiatives on the combined ratio was 1.4% (2013: 0.8%). The discounting expense of $16.0 million in 2014 was driven by declines in market yields which increased the fair value of our claim liabilities, compared to an increase in market yields in 2013 resulting in a discounting recovery of $8.4 million. This expense was more than offset by recognized gains in our fair value through profit or loss ( FVTPL ) bond portfolio, which we use to manage interest rate exposure to our claim liabilities (see Investment income below). INVESTMENT INCOME Figure 5 shows the composition of investment income recorded in the consolidated statement of comprehensive income for the year ended December 31. FIGURE 5 (in millions of dollars, except as otherwise noted) $ Change % Change Interest income (2.8) (3.5%) Dividend income % Total interest and dividend income % Realized gains on available for Sale ("AFS") portfolio % Realized gains on FVTPL bonds (3.5) (20.8%) Unrealized gains (losses) on FVTPL bonds 14.6 (22.0) % Net impairment loss on AFS portfolio (4.7) (10.7) % Total recognized gains on investments % Total investment income % Total investment income was $164.2 million in 2014 (2013: $105.0 million), an increase of $59.2 million over the prior year. Interest income decreased by $2.8 million in 2014 compared to the prior year due to the persistent low interest rate environment. As of the end of 2014, the market yield of the consolidated bond portfolio declined 41 basis points year over year. To optimize the performance of the investment portfolio, we invested more heavily in investment grade preferred equities, resulting in a $6.0 million increase in dividend income. A subset of the bond portfolio, which is matched in quantum and duration to the claim reserves, is designated as FVTPL. This designation 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. Changes in the fair value of FVTPL instruments are included in recognized gains on investments in the consolidated statement of comprehensive income. 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 income ( OCI ) until the instrument is disposed of or considered to be impaired. 13

16 MANAGEMENT S DISCUSSION AND ANALYSIS Realized gains on the AFS portfolio increased $16.9 million in 2014 compared to the prior year, primarily driven by recognized gains in Canadian common equities. The net realized and unrealized gains on the FVTPL bond portfolio totaled $27.9 million in 2014 compared to a $5.2 million loss in the prior year. These gains were largely driven by increases in the fair value of these investments as interest rates declined throughout the year. Investment impairment losses declined to $4.7 million compared to $10.7 million in 2013, as 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 (EXPENSE) INCOME In 2014, other expenses of $3.6 million primarily consisted of investment expenses and costs incurred to prepare for demutualization. In 2013, other income included $26.6 million in gains in our defined benefit obligation which was partially offset by investment expenses and demutualization costs. These gains were triggered by a plan curtailment and our decision to discontinue a past practice of granting discretionary indexation increases to members of the defined benefit plan. RESTRUCTURING EXPENSES Costs for the BTP incurred in 2014 totaled $14.3 million (2013: $37.7 million). Of this amount, $13.0 million (2013: $14.3 million) was included in underwriting expenses and $1.3 million (2013: $23.4 million) was included in restructuring expenses. The amounts above that have been recorded in underwriting expenses pertain to expenses related to BTP that have not met the criteria for classification as restructuring expenses. As the BTP was completed in 2014, the level of spend decreased from the prior year. INCOME BEFORE INCOME TAXES Income before income taxes in 2014 was $104.9 million, compared to $110.7 million in 2013 as underwriting losses were more than offset by investment income. INCOME TAX EXPENSE (RECOVERY) The effective tax rate for 2014 was 19.7%, marginally lower than the 20.7% effective tax rate in The effective tax rate continues to be lower than the statutory rate of 26.4% mainly due to the impact of non-taxable Canadian dividend income. CAPITAL STRENGTH In 2014, we continued to grow our capital base. Total equity increased $108.0 million, or 6.9%, to almost $1.7 billion. The minimum capital test ( MCT ) ratio continues to be strong reaching 295.4% as at December 31, 2014 (2013: 295.2%), significantly in excess of regulatory requirements. 14

17 MANAGEMENT S DISCUSSION AND ANALYSIS 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 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 2014 and 2013: 2014 GWP BY LINE OF BUSINESS 2013 GWP BY LINE OF BUSINESS % 26% 41% 19% 41% 19% 14% 14% Personal auto Commercial property and liability Personal property Commercial auto 2014 GWP BY REGION 2013 GWP BY REGION Ontario Western Canada 57% 29% 57% 28% Atlantic 7% 8% 1% 6% 1% 6% Quebec Other Our business mix remained stable in We increased gross written premiums by $43.8 million, or 2.3% in 2014 and generated premium growth across all lines of business except commercial auto, which declined slightly due to the non-renewal of certain noncore fronting arrangements and the exit of unprofitable lines of business. The growth in GWP in 2014 was led by personal lines which grew 3.8% while commercial lines grew 0.1%. GWP growth in 2014 was concentrated in Ontario (2.4%), Western Canada (5.1%) and Quebec (2.2%). The Atlantic region GWP declined by 3.6% in 2014 due primarily to our decision to exit unprofitable business lines in Newfoundland and Labrador. 15

18 MANAGEMENT S DISCUSSION AND ANALYSIS UNDERWRITING PERSONAL LINES Figure 6 presents selected results of operations of the personal lines of business for the year ended December 31. FIGURE 6 (in millions of dollars, except as otherwise noted) Policies in force (thousands) $ Change % Change Automobile % Property % Total % Gross written premiums Automobile % Property % Total 1, , % Net premiums earned Automobile % Property (0.8) (0.2%) Total 1, , % Underwriting income (loss) (undiscounted) Automobile (30.5) (60.9%) Property 13.2 (3.5) % Total (13.8) (29.6%) PERSONAL AUTOMOBILE RATIOS PERSONAL PROPERTY RATIOS TOTAL PERSONAL LINES RATIOS 120% % % claims expenses combined 0 claims expenses combined 0 claims expenses combined Personal auto GWP grew by 4.0% in 2014, supported by strong PIF growth of 6.1%. The increase in GWP was outpaced by the PIF growth. A change in the mix of business towards regions with higher average premiums was partially offset by mandated rate decreases in Ontario that were implemented during the year. These lower rates in Ontario supported new business growth and increased retention levels, which helped to offset the decline in average written premiums in this region. The personal auto combined ratio increased 4.2 percentage points over The increase was due to lower levels of favourable claims development, particularly in Western Canada and Ontario auto, and slightly higher net claims frequency, which was impacted by the harsh winter conditions experienced in the first quarter. Personal property GWP increased by 3.2% in 2014, supported by a 0.6% increase in PIF. The increase in GWP outpaced the PIF growth due to rate increases in Ontario and Western Canada. The personal property combined ratio decreased by 4.9 percentage points over 2014, mainly due to lower net claims frequency and severity. Prior year claims were heavily impacted by the Alberta and the Greater Toronto Area flood events. We believe that our continued investments in predictive analytics, underwriting sophistication, and operational effciency will continue to drive profitable growth in personal lines. The impact of the mandated rate decreases on longer term profitability for Ontario auto will continue to develop in 2015 as policies are issued and renewed at lower rates. 16

19 MANAGEMENT S DISCUSSION AND ANALYSIS UNDERWRITING COMMERCIAL LINES Figure 7 presents selected results of operations of the commercial lines of business for the year ended December 31. FIGURE 7 (in millions of dollars, except as otherwise noted) $ Change % Change Policies in force (thousands) Automobile Property and liability Total (3.4) (1.8%) Gross written premiums Automobile Property and liability Total % Net premiums earned Automobile Property and liability Total % Underwriting income (loss) (undiscounted) Automobile Property and liability 11.2 (82.4) (83.9) (1.2) (2.2) (4.8) (23.8) 1.5 (2.2%) (1.6%) (1.8%) 1.1% 6.9% 4.0% (68.0%) 1.8% Total (71.2) (48.9) (22.3) (45.6%) COMMERCIAL AUTOMOBILE RATIOS 120% claims expenses combined COMMERCIAL PROPERTY AND LIABILITY RATIOS 120% claims expenses combined TOTAL COMMERCIAL LINES RATIOS 120% claims expenses combined Commercial auto GWP decreased 1.8% in 2014, while PIF decreased 2.2% in the same period. Excluding the impact of the nonrenewal of certain non-core fronting arrangements and the exit of unprofitable lines of business, commercial auto GWP increased 6.5%. 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 increased by 10.5 percentage points in 2014 due to increases in the frequency and net severity of claims, driven by the unusually harsh winter during the first quarter of 2014 and persistent smaller weather-related events throughout the year. Despite this, we achieved a strong combined ratio of 95.5% in Commercial property and liability GWP increased 1.1% in 2014 despite a decrease in PIF of 1.6%. This was primarily due to the impact of targeted rate increases in all regions aimed at improving profitability. The commercial property and liability combined ratio decreased by 1.0 percentage point over the prior year as increased adverse development was more than offset by reductions in large losses and catastrophe losses compared to We continue to focus on underwriting discipline, roll out of product enhancements, targeted rate increases, and continue the implementation of sophisticated pricing models to achieve rate adequacy in key lines of commercial business, which we believe will significantly improve operating performance of the commercial lines of business. However, we expect that the impact of these actions will not be immediately realized as rate increases and product changes take time to implement and earn through the book of business. 17

20 MANAGEMENT S DISCUSSION AND ANALYSIS section 4 business developments and operating environment ONTARIO PERSONAL AUTO ENVIRONMENT In August 2013, the Ontario government introduced a mandate to improve affordability of auto insurance for consumers through a 15% rate reduction across the industry over a two year period. All insurance writers in Ontario were required to complete rate filings with the Financial Services Commission of Ontario between the end of 2013 and early As a result, industry rates are down by an average of 6%, while the mandated reductions resulted in us reducing rates by an average of 10.4%. The impact of the mandated rate decreases on longer term profitability for Ontario auto will continue to develop in 2015 as policies are issued and renewed at lower rates. At Economical, additional rate segmentation was established with the rate reductions, which will help to mitigate future losses and maintain profitability. We support the objectives included in Bill 15 Fighting Fraud and Reducing Automobile Insurance Rates Act, 2014 ( Bill 15 ), however Bill 15 must be accompanied with robust regulations in order to have a meaningful impact on claim costs in Ontario auto. We strongly believe that a long-term, permanent solution is required to bring costs more in line with those across other provinces in Canada. 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, where the Company and the P&C industry in Canada endured the worst catastrophe loss year in its history. Although catastrophe losses were lower in 2014 than the record levels set in 2013, we continued to be heavily impacted by weather events mainly related to wind and rain. These weather events are expected to continue to create increased volatility in results, particularly in our property lines of business. CAPITAL MARKETS There was significant volatility in the markets in 2014, especially in the fourth quarter, as oil prices declined significantly and the outlook for the Canadian economy turned negative. The TSX ended the year with a total return of 10.6% year to date, while the FTSE TMX bond universe returned 8.8% year to date as increased global economic concerns created an aversion to risk and drove bond yields lower. Declining interest rates combined with rising equity markets in the year resulted in pre-tax unrealized gains of $66.1 million, and realized gains of $48.1 million. Realized gains were slightly offset by impairments of $4.7 million recorded in the year. REVISED MCT GUIDELINE On September 24, 2014, the Offce of the Superintendent of Financial Institutions Canada ( OSFI ) released a revised MCT Guideline for P&C insurers effective on January 1, OSFI measures the financial strength of P&C companies through the MCT calculation. The purpose of the revision was to create a more robust risk-based capital framework that better aligns capital requirements to the risks faced by P&C insurers. Based on our analysis, the impact to our regulatory ratio will be positive. The benefits will phase in over the next three years. 18