Canada Life Financial Corporation ANNUAL REPORT

Transcription

1 Canada Life Financial Corporation 2008 ANNUAL REPORT

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3 CORPORATE PROFILE Canada Life Financial Corporation (CLFC) was established in CLFC s principal subsidiary, The Canada Life Assurance Company, was founded in 1847 and provides insurance and wealth management products and services in Canada, the United Kingdom, Isle of Man, Ireland and Germany. CLFC and Canada Life are subsidiaries of The Great-West Life Assurance Company, which together with London Life Insurance Company, has more than $162 billion* in assets under administration. The companies are members of the Power Financial Corporation group of companies. * as of December 31, 2008 Table of Contents 1 Corporate Profile 2 Directors Report 4 Management s Discussion and Analysis 5 Consolidated Operating Results 11 Consolidated Financial Position 15 Liquidity and Capital Management and Adequacy 19 Risk Management and Control Practices 25 Summary of Critical Accounting Estimates 28 Accounting Policies 29 Segmented Operating Results 29 Individual Insurance & Investment Products 32 Group Insurance 33 Europe/Reinsurance 38 United States 38 Corporate 38 Other Information 42 Financial Reporting Responsibility 43 Consolidated Financial Statements 43 Summaries of Consolidated Operations 44 Consolidated Balance Sheets 45 Consolidated Statements of Surplus 46 Summaries of Consolidated Comprehensive Income 47 Consolidated Statements of Cash Flows 48 Segregated Funds Consolidated Net Assets and Consolidated Statements of Changes in Net Assets 49 Notes to Consolidated Financial Statements 79 Auditors Report 79 Appointed Actuary s Report 80 Five Year Summary 81 Subsidiaries of Canada Life Financial Corporation 82 Directors and Officers 83 Policyholder and Shareholder Information Canada Life Financial Corporation Annual Report

4 DIRECTORS REPORT In 2008 Canada Life Financial Corporation (CLFC) delivered excellent results in a very difficult economic environment. Conservative investment policies, a strong risk-averse culture and disciplined expense management served the company well in this challenging period in both Canada and Europe. Measures of CLFC s 2008 performance include: Common shareholder net income before adjustments, at $1 billion, increased 27% from Premiums and deposits at $22.1 billion were up 32% over General account assets were $61.4 billion, an increase of 18% from Segregated funds net assets decreased 17% from 2007, reflecting lower market values. CLFC subsidiary Canada Life s financial strength is reflected in its Minimum Continuing Capital and Surplus Requirements (MCCSR) ratio. At the end of 2008, Canada Life s MCCSR ratio was 214% compared with 226% in 2007, well above regulatory requirements. Ratings are another important indicator of our financial strength. In 2008, all five agencies which rate Canada Life reaffirmed strong ratings for the company and its subsidiaries. Raymond L. McFeetors D. Allen Loney Canada Life, together with Great-West Life, is a leading provider of individual disability insurance and critical illness insurance for Canadians. A new child critical illness insurance product introduced in 2008 strengthens the product shelf and provides clients with another important coverage option for their families. Canada Life is a leading provider of creditor insurance in Canada for mortgages, loans, credit cards, lines of credit and leases, through leading financial institutions, automobile dealerships and other lending institutions. In 2008, the creditor insurance and direct marketing operations continued their focus on customer service. Canada In 2008 Canada Life maintained a strong market position in its individual insurance and individual investments businesses despite the troubled financial markets. Expense management was a key focus in all parts of the business. The company s individual life insurance and living benefits businesses grew faster than the market, while its individual retirement and investment services business maintained positive net cash flows amidst the significant market turmoil. Canada Life s products are distributed through the independent advisor channel as well as national accounts including Investors Group. The company s distribution structure supports the strong persistency of business, provides a strategic advantage and contributes to strong market share across the lines of business. Together, Canada Life, Great-West Life and London Life remain Canada s number one provider of individual life insurance. The companies believe participating life insurance offers consumers important advantages and choice as part of a sound financial security plan and they continue to be a leader in this area. The 2008 dividend scale for participating policies issued by Canada Life and the former Crown Life will continue to apply in The dividend scale for former New York Life participating policies increased effective January 1, Canada Life, together with Great-West Life and London Life, is a leading provider of individual segregated funds, which the companies continue to promote as unique solutions in times of uncertain markets. Europe Canada Life has operations in the United Kingdom, Isle of Man, Ireland and Germany. In 2008, challenging global credit, equity and foreign exchange markets led to lower sales in the European operations. The company maintained a continued focus on credit and expense controls and despite lower sales, the European operations are in a strong position to take advantage of opportunities. In February, Canada Life subsidiary Canada Life International Re Limited assumed by way of indemnity reinsurance, a large block of U.K. payout annuities. The company continues to seek opportunities to expand its position in core European markets. In the U.K., Canada Life maintained or improved its market share in a very difficult market in its core businesses group insurance, payout annuities and wealth management. An enhanced annuity product launched in the first half of the year was well received in both the individual and group markets. Group reached the $2 million milestone of new business premium quoted and written electronically a significant achievement. In a difficult and challenging environment, Canada Life s U.K. business remains very well positioned. In Germany, Canada Life operates in the independent broker market and is one of the leading insurers for unit linked products in the broker segment. Despite a difficult market environment due to legal changes and the current situation in the financial sector, the unitized with profit and unit linked pension products performed well. The GENERATION basic individual pension product was successfully re-launched. Current surveys confirm Canada Life Europe s strong position in this market. In particular, independent brokers again voted the company a leader in various product segments. 2 Canada Life Financial Corporation Annual Report 2008

5 Canada Life is a leading provider of traditional mortality, financial and annuity reinsurance solutions to life insurers in the U.S. and in international markets, through its Canada Life Reinsurance division. In 2008, we continued to leverage our financial strength, strong risk-averse culture and excellent client relationships to achieve strong business results. Giving back to communities As an organization and individuals, the companies are proud to contribute to the development of stronger communities. The financial and voluntary support provided to hundreds of charitable, non-profit and community-based organizations is aimed at meeting a high standard of corporate citizenship. Management appointments In May 2008, following a distinguished career as President and Chief Executive Officer, Raymond L. McFeetors was appointed Chairman of the Board, succeeding Robert Gratton. D. Allen Loney, previously the Company s Chief Actuary, was appointed as President and CEO of Canada Life and Canada Life Financial Corporation, in succession to Mr. McFeetors. Additionally, new senior management appointments were announced in May 2008 from amongst longstanding members of the current executive management team: William L. Acton as President and CEO of Canada Life Capital Corporation (CLCC), the holding company for the European operations; and Paul Mahon as President and Chief Operating Officer, Canada, following the retirement of Denis J. Devos. Board of Directors At Canada Life s 2008 Annual Meeting of Shareholders and Policyholders, tribute was paid to Robert Gratton for his outstanding contribution to the growth and evolution of the organization during his five-year tenure as Chairman of the Board. Also in 2008, Robert Gratton retired from the Board after serving as a Director since July Mr. Gratton made an outstanding contribution to Canada Life through his vision, drive and wisdom he applied to business issues. The Board of Directors would like to express their sincere appreciation and gratitude to Mr. Gratton for his guidance and leadership throughout the years. In addition to Robert Gratton, four Directors of the Corporation retired in 2008: Gail S. Asper, Gérard Veilleux, Peter Kruyt and William T. McCallam. Four new Directors were elected to the Board: D. Allen Loney, President and CEO of Canada Life and Canada Life Financial Corporation; Marc A. Bibeau, President of Beauward Shopping Centers Ltd.; Chaviva M. Hošek, President and Chief Executive Officer of The Canadian Institute for Advanced Research; and Philip K. Ryan, Executive Vice-President and Chief Financial Officer of Power Financial Corporation and Power Corporation of Canada. On behalf of the Board of Directors, it is our pleasure to recognize the professionalism and continuing dedication of the people across our companies who serve our clients and distribution associates worldwide. We also thank our clients, distribution associates and shareholders for their continued support. Raymond L. McFeetors Chairman of the Board D. Allen Loney President and Chief Executive Officer Canada Life Financial Corporation Annual Report

6 MANAGEMENT S DISCUSSION AND ANALYSIS The Management s Discussion and Analysis (MD&A) presents management s view of the financial condition, results of operations and cash flows of Canada Life Financial Corporation (CLFC or the Company) for the three and twelve months ended December 31, 2008 compared with the same periods in The MD&A provides an overall discussion, followed by analysis of the performance of the Company s business units. BUSINESSES OF CLFC CLFC is a diversified international financial services company offering protection and wealth management products to individuals and groups, principally in Canada, the United Kingdom, the United States, Ireland and Germany. The Company also provides life reinsurance operating principally in the United States. BASIS OF PRESENTATION AND SUMMARY OF ACCOUNTING POLICIES The consolidated financial statements of CLFC, which are the basis for data presented in this report, have been prepared in accordance with Canadian generally accepted accounting principles (GAAP) and presented in Canadian dollars unless otherwise indicated. CAUTIONARY NOTE REGARDING FORWARD-LOOKING INFORMATION This report contains some forward-looking statements about the Company, including its business operations, strategy and expected financial performance and condition. Forward-looking statements include statements that are predictive in nature, depend upon or refer to future events or conditions, or include words such as expects, anticipates, intends, plans, believes, estimates or negative versions thereof and similar expressions. In addition, any statement that may be made concerning future financial performance (including revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future action by the Company, including statements made by the Company with respect to the expected benefits of acquisitions or divestitures, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are inherently subject to, among other things, risks, uncertainties and assumptions about the Company, economic factors and the financial services industry generally, including the insurance and mutual fund industries. They are not guarantees of future performance, and actual events and results could differ materially from those expressed or implied by forward-looking statements made by the Company due to, but not limited to, important factors such as sales levels, premium income, fee income, expense levels, mortality experience, morbidity experience, policy lapse rates and taxes, as well as general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, catastrophic events, and the Company s ability to complete strategic transactions and integrate acquisitions. The reader is cautioned that the foregoing list of important factors is not exhaustive, and there may be other factors, including factors set out herein under Risk Management and Control Practices, and any listed in other filings with securities regulators, which are available for review at The reader is also cautioned to consider these and other factors carefully and to not place undue reliance on forward-looking statements. Other than as specifically required by applicable law, the Company has no intention to update any forward-looking statements whether as a result of new information, future events or otherwise. CAUTIONARY NOTE REGARDING NON-GAAP FINANCIAL MEASURES This report contains some non-gaap financial measures. Terms by which non-gaap financial measures are identified include, but are not limited to, earnings before restructuring charges, adjusted net income, net income adjusted, earnings before adjustments, constant currency basis, premiums and deposits, sales and other similar expressions. Non-GAAP financial measures are used to provide management and investors with additional measures of performance. However, non-gaap financial measures do not have standard meanings prescribed by GAAP and are not directly comparable to similar measures used by other companies. Refer to the appropriate reconciliations of these non-gaap financial measures to measures prescribed by GAAP. 4 Canada Life Financial Corporation Annual Report 2008

7 MANAGEMENT S DISCUSSION AND ANALYSIS CONSOLIDATED OPERATING RESULTS Selected consolidated financial information (in $ millions except per common share amounts) For the three months ended December 31 For the twelve months ended December % Change % Change Total premiums and deposits $ 2,233 $ 2,288-2% $ 22,102 $ 16,693 32% Fee and other income % % Paid or credited to policyholders 1,851 2,034-9% 16,234 11,193 45% Summary of net income attributable to: Participating account (11) (5) (14) 5 Perpetual preferred shareholders Common shareholder adjusted % 1, % Adjustments after tax (1) 66 Net income common shareholder (2) % 1, % Per common share Basic earnings adjusted $ 1.88 $ % $ 6.53 $ % Adjustments after tax (1) 0.41 Basic earnings % % Dividends paid % Book value % At December 31 Total assets $ 61,439 $ 52,054 18% Segregated funds net assets 25,896 31,069-17% Total assets under administration $ 87,335 $ 83,123 5% Participating account surplus $ 31 $ 36-14% Shareholder equity 4,912 4,242 16% Total participating account surplus and shareholder equity $ 4,943 $ 4,278 16% (1) During 2007, net income attributable to the common shareholder was reduced by $66 million after-tax as a result of a provision for a Canadian retirement plan. Net income and basic earnings per common share are presented before adjustments as a non-gaap financial measure of earnings performance. (2) Net income attributable to the common shareholder for the year ended December 31, 2008 includes asset impairment charges of $60 million after-tax. REINSURANCE TRANSACTIONS Standard Life Transaction On February 14, 2008, the Company s indirect wholly-owned Irish reinsurance subsidiary, Canada Life International Re Limited (CLIRe) signed an agreement with Standard Life Assurance Limited (Standard Life), a U.K. based provider of life, pension and investment products, to assume by way of indemnity reinsurance, a large block of U.K. payout annuities (the Standard Life transaction). The reinsurance transaction increased premium income, paid or credited to policyholders, funds held by ceding insurers and policyholders liabilities by approximately $12.5 billion. U.S. Branch Recapture Transaction Effective June 1, 2007, The Canada Life Assurance Company s (Canada Life) U.S. branch recaptured all of the U.S. life and annuity business that had been ceded to Great-West Life & Annuity Insurance Company (GWL&A), an affiliated company, in 2003 (U.S. branch recapture transaction). This recapture transaction resulted in: Summaries of Consolidated Operations: an increase of $2,055 million (US$1,868 million) in acquired premiums with a corresponding increase in actuarial liabilities (Paid or Credited to Policyholders). Consolidated Balance Sheets: an increase in invested assets of $1,690 million (US$1,594 million), an increase in other assets of $26 million (US$25 million), an increase in policyholder liabilities of $2,084 million (US$1,966 million) and a decrease in funds held under reinsurance contracts of $368 million (US$347 million). Canada Life Financial Corporation Annual Report

8 MANAGEMENT S DISCUSSION AND ANALYSIS CLICC TRANSACTION Effective April 1, 2007 the Canada Life Insurance Company of Canada (CLICC), a wholly-owned subsidiary of Canada Life, and The Great-West Life Assurance Company (Great-West Life), the Company s indirect parent, entered into an Indemnity Reinsurance Agreement pursuant to which CLICC assumed liabilities by coinsurance including certain blocks of non-participating group life and health insurance policies, non-participating individual life reinsurance, non-participating group payout annuities and non-participating individual payout annuities (the CLICC transaction). The initial transaction resulted in the following: Summaries of Consolidated Operations: an increase in premium income of $3,535 million with a corresponding increase in actuarial liabilities (Paid or Credited to Policyholders). Consolidated Balance Sheets: an increase in invested assets of $3,775 million, an increase in actuarial liabilities of $3,535 million and an increase in policyholder funds of $240 million. FINANCIAL MARKETS Financial Market Volatility Global credit, equity and foreign exchange markets continue to experience significant volatility as a result of credit and liquidity concerns relating ultimately to the deterioration in the United States mortgage and housing markets. These concerns have led to the disruption in the normal functioning of credit markets around the world, unprecedented volatility and have resulted in many financial institutions experiencing financial difficulty. Governments across the globe have introduced measures intended to instill confidence in financial markets for financial institutions and their clients. The Company has observed that liquidity in the fixed income market has marginally improved in recent weeks. Liquidity has not returned to normal levels, however new issues of financial instruments have successfully come to the market with some oversubscribed and a modest level of trading is taking place. The S&P TSX index declined 24% in the fourth quarter which has resulted in a decline of 35% since the beginning of the year. Also, in the quarter the S&P 500 index declined 23% and the FTSE 100 index declined 10% which has resulted in declines of 38% and 31% respectively since the beginning of the year. Consequently, the average S&P TSX index level for the fourth quarter of 2008 was 34% lower than the same period in Similarly the average index levels for the S&P 500 and the FTSE 100 were down 39% and 34% respectively from 2007 levels. The declines in average index levels were more moderate when comparing the year-to-date periods for 2008 and The average index level for the S&P TSX for the year was down 8% compared to 2007 and the S&P 500 and the FTSE 100 were 17% and 16% respectively. Period ended Year ended 2008 Dec Sept June Mar Year ended 2007 S&P TSX Index Close 8,988 8,988 11,753 14,467 13,350 13,833 13,833 14,099 13,907 13,166 Average 12,486 9,108 13,150 14,400 13,269 13,620 13,885 13,816 13,806 12,986 S&P 500 Index Close ,166 1,280 1,323 1,468 1,468 1,527 1,503 1,421 Average 1, ,252 1,372 1,351 1,477 1,496 1,489 1,497 1,424 FTSE Index Close 4,434 4,434 4,902 5,626 5,702 6,457 6,457 6,467 6,608 6,308 Average 5,363 4,260 5,354 5,983 5,881 6,403 6,455 6,362 6,537 6,266 Dec Sept June Mar Impact on Operating Results Impairment charges In 2008, the Company recorded a charge for the impairment of assets of $60 million after-tax. This charge is considered to be other-than-temporary, and has reduced net income attributable to the common shareholder reported by the Company. Other developments Life insurers offering segregated fund or variable annuity investment performance guarantees have been adversely impacted by low interest rates and equity market declines. The high level of equity market volatility has increased the cost of dynamic hedging programs and in turn restricted the availability of reinsurance. In response, we expect life insurers to revise product designs to reduce benefit costs and to increase prices. The Company will monitor developments in this area and will consider introducing lifetime income guarantee products in 2009 to reinforce our market leading position in Canada and to extend our U.S. and European product and distribution range. The Company has temporarily suspended withdrawals and transfers-out from its Real Estate Segregated Fund (the Fund), effective the close of business December 15, The economic situation in 2008 significantly increased investor s preference for liquidity, which impacted equity markets, including real estate. One of the impacts was an increase in withdrawals and transfers-out from the Fund. In accordance with the terms of the Information Folder governing the Fund, management determined the need to temporarily suspend withdrawals and transfers-out from the Fund in order to preserve unitholder value, to balance the interests of all unitholders and to treat everyone fairly. The Company is working to rebuild liquidity to support the long-term viability of the fund, and to enable the suspension to be lifted. 6 Canada Life Financial Corporation Annual Report 2008

9 MANAGEMENT S DISCUSSION AND ANALYSIS Unrealized mark-to-market losses In addition to other-than-temporary impairment charges, the deterioration in financial markets, as well as extreme illiquidity of the bond markets coupled with indeterminable liquidity premiums, has produced a general widening of credit spreads and lower market prices for fixed income investments. This has resulted in a decline in the fair value of Lifeco s bond investments. At December 31, 2008, gross unrealized bond losses totaled $3.7 billion. Of the $3.7 billion, $3.6 billion is related to bonds that have been classified as held for trading and $0.1 billion is related to bonds that have been classified as available for sale. The held for trading bonds are held primarily in support of actuarial liabilities with changes in the fair value of these assets, excluding changes on other-than-temporarily impaired assets, offset by a corresponding change in the value of the actuarial liabilities. The Company has the ability and intent to hold the securities with unrealized losses until a recovery of the fair value, which may be maturity; therefore, the Company does not consider these investments to be other than temporarily impaired at December 31, Gross unrealized bond losses (1) C$ billions December 31, 2008 September 30, 2008 Classification Held for trading $ (3.6) 97% $ (3.3) 97% Available for sale (0.1) 3 (0.1) 3 Total other general fund assets $ (3.7) 100% $ (3.4) 100% (1) Includes unrealized bond losses on funds held by ceding insurers. Impact on Liquidity and Financial Condition The Company s liquidity requirements are self-funded, with short term obligations being met by generating internal funds and maintaining adequate levels of liquid investments. At December 31, 2008, Canada Life held cash and liquid short term investments of $2.7 billion. In addition, the Company and its operating subsidiaries held Canada, United States and foreign government bonds of $11.3 billion. The Company s financial condition and regulatory capital position remained strong at December 31, In this regard, Canada Life s consolidated Minimum Continuing Capital and Surplus Requirements (MCCSR) ratio was 214%, which is above the Company s target operating range. During the fourth quarter, the unfavourable impact of equity markets on capital requirements associated with certain segregated fund contracts with investment performance guarantees was offset by the favourable impact of growth in retained earnings combined with the favourable impact of changes in assumptions and methods. While the Company s financial condition remained strong at December 31, 2008, further deterioration in financial markets would be expected to have a negative impact. Measurement Uncertainty The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet date and the reported amounts of revenues and expenses during the reporting period. The results of the Company reflect management s judgments regarding the impact of prevailing global credit, equity and foreign exchange market conditions. Financial instrument carrying values currently reflect the illiquidity of the markets and the liquidity premiums embedded in the market pricing methods the Company relies upon. The estimation of actuarial liabilities relies upon investment credit ratings. The Company s practice is to use third party independent credit ratings where available. Credit rating changes may lag developments in the current environment. Subsequent credit rating adjustments will impact actuarial liabilities. In addition to the Company s direct investments in certain financial institutions, the Company has contractual business relationships with these financial institutions. Given the current uncertainty associated with these entities, normal business conditions do not prevail and the Company s contractual business relationships may be impacted. Given the uncertainty surrounding the continued volatility in these markets, and the general lack of liquidity in financial markets, the actual financial results could differ from the estimates made in preparation of the financial statements. Canada Life Financial Corporation Annual Report

10 MANAGEMENT S DISCUSSION AND ANALYSIS CONSOLIDATED OPERATING RESULTS NET INCOME For the twelve months ended December 31, 2008, CLFC s net income was $1,043 million compared to $770 million for the same period in Net income attributable to the common shareholder was $1,048 million or $6.53 per common share compared to $756 million or $4.71 per common share in The Net income by segment 2007 results include a provision for a Canadian retirement plan which impacted earnings per common share by $0.41. Excluding this charge, net income to the common shareholder-adjusted in 2008 grew 27% from $822 million in Net income for the participating account before policyholder dividends was $212 million compared to $225 million for For three months ended December 31 For twelve months ended December % Change % Change Attributable to participating account Net income before policyholder dividends $ 33 $ 58-43% $ 212 $ 225-6% Policyholder dividends % % Total $ (11) $ (5) $ (14) $ 5 Attributable to shareholder Preferred shareholder dividend $ 2 $ 2 $ 9 $ 9 Common shareholder Individual Insurance & Investment Products $ 32 $ 42-24% $ 230 $ 83 Group Insurance % % Europe/Reinsurance % % United States % % Corporate (5) Total common shareholder $ 301 $ % $ 1,048 $ % Total net income $ 292 $ % $ 1,043 $ % Net income attributable to the participating account For the fourth quarter 2008, net income attributable to the participating account was a charge of $11 million, a decrease of $6 million from Net income attributable to the participating account for the full year 2008 was a charge of $14 million, a decrease of $19 million from 2007 due to a reduction in fair value of assets from financial market volatility, resulting in lower income. Net income attributable to the common shareholder Individual Insurance & Investment Products (IIIP) For the fourth quarter, net income was $32 million, compared to $42 million in 2007, primarily due to a decrease in the value of future spreads from universal life and lower fee income. For the full year 2008, net income was $230 million compared to $83 million in 2007, due to higher actuarial basis change releases and Cash Flow Valuation Method gains, partly offset by higher tax expense. Group Insurance For the fourth quarter, net income was $24 million compared to $75 million in 2007 attributable to a decrease in group health morbidity experience. The 2007 results included a gain from aggregate stop loss reinsurance of $24 million, and a $19 million decrease in income taxes due to a reduction in statutory tax rates. For the full year 2008, net income was $67 million compared to $118 million in 2007 due to unfavourable basis change, the inclusion of the gain from the aggregate stop loss reinsurance in 2007 and a decrease in income taxes realized in Europe/Reinsurance For the fourth quarter, net income was $191 million compared to $118 million in Insurance & Annuities increased $49 million and Reinsurance increased $25 million, and Corporate (Europe/Reinsurance) decreased $1 million. For the full year 2008, net income was $651 million compared to $504 million in Insurance & Annuities increased $78 million, Reinsurance increased $85 million, and Corporate (Europe/ Reinsurance) decreased $16 million. United States For the fourth quarter, net income was $14 million compared to $13 million in 2007, and for the full year 2008, net income was $26 million compared to $56 million in Corporate For the fourth quarter, net income was $40 million compared to $10 million in Net income for the full year 2008, was $74 million compared to a charge of $5 million in Refer to each segment section for further detail. 8 Canada Life Financial Corporation Annual Report 2008

11 MANAGEMENT S DISCUSSION AND ANALYSIS PREMIUMS AND DEPOSITS AND SALES For the three months ended December 31 For the twelve months ended December 31 Premiums and deposits % Change % Change Business/Product Individual Insurance & Investment Products $ 514 $ % $ 2,006 $ 4,796-58% Group Insurance % 631 1,539-59% Europe/Reinsurance 1,522 1,489 2% 19,289 8, % United States % 176 2,216-92% Total premiums and deposits $ 2,233 $ 2,288-2% $ 22,102 $ 16,693 32% Summary by Type Risk-based products $ 1,064 $ 1,124-5% $ 17,348 $ 10,728 62% Segregated funds deposits Individual products 1,140 1,115 2% 4,620 5,788-20% Group products % % Total premiums and deposits $ 2,233 $ 2,288-2% $ 22,102 $ 16,693 32% For the three months ended December 31 For the twelve months ended December 31 Sales % Change % Change Business/Product Individual Insurance & Investment Products $ 385 $ % $ 1,660 $ 2,189-24% Group Insurance % % Europe Insurance & Annuities 1,349 1,058 28% 5,004 6,087-18% Total sales $ 1,752 $ 1,580 11% $ 6,715 $ 8,324-19% Premiums and deposits include premiums on risk based insurance and annuity products and deposits on individual and group segregated fund products. Refer to each segment section for further detail. NET INVESTMENT INCOME Net investment income For the three months ended December 31 For the twelve months ended December % Change % Change Investment income earned $ 767 $ % $ 3,175 $ 2,502 27% Amortization of net realized and unrealized gains on real estate investments (10) 10 (2) 49 (Provision) recovery of credit losses (6) 1 (7) 1 Other net realized gains/(losses) % % Regular investment income % 3,228 2,582 25% Investment expenses (10) (9) (31) (32) Regular net investment income % 3,197 2,550 25% Changes in fair value of held for trading assets % (2,595) (792) Net investment income $ 1,178 $ 1,302-10% $ 602 $ 1,758-66% Net investment income for the quarter ended December 31, 2008 decreased by $124 million compared to the same period last year. The year over year decrease in fair value of held for trading assets of $302 million partly offset by an increase in regular net investment income of $178 million account for the change. Regular net investment income increased mainly due to investment income earned from the Standard Life transaction partially offset by lower amortization of net realized and unrealized gains on real estate investments. The changes in fair value on held for trading assets was due to a decline in bonds and stocks attributable to increased credit spreads and equity market declines. For the twelve months ended December 31, 2008, net investment income decreased by $1,156 million compared to the same period last year. The year over year decrease in fair value of held for trading assets of $1,803 million partly offset by an increase in regular net investment income of $647 million was due to the same reasons as the in quarter period. The changes in fair value on held for trading assets includes a charge for impairment of assets. Canada Life Financial Corporation Annual Report

12 MANAGEMENT S DISCUSSION AND ANALYSIS FEE AND OTHER INCOME In addition to providing traditional risk-based insurance products, the Company also provides certain products on a fee-for-service basis. The most significant of these products are segregated funds, Fee and other income for which the Company earns investment management and other premium-based fees. For the three months ended December 31 For the twelve months ended December % Change % Change Segregated funds and other $ 194 $ 199-3% $ 747 $ 783-5% Fee income derived from the management of segregated funds assets and other asset management services decreased $5 million to $194 million for the three months ended December 31, 2008 compared to 2007, mainly due to a decline in average segregated fund assets and lower business levels, partly offset by a shift to higher fee generating assets and growth in the U.K. and Isle of Man. For the twelve months ended December 31, 2008, fee income was $747 million compared to $783 million for the twelve months ended December 31, 2007 mainly due to a decline in average segregated fund assets in the last half of 2008, and lower business levels in Ireland and Germany. The Company expects fee income on segregated funds and other to decline in 2009 due to the decline in equity markets and lower average assets. PAID OR CREDITED TO POLICYHOLDERS This amount includes increases in policy liabilities, claims, surrenders, annuity and maturity payments, dividend and experience refund payments for risk-based products, but does not include payment amounts for fee-based products (segregated funds). In aggregate, $1.9 billion was paid or credited to policyholders in the fourth quarter of 2008 compared to $2.0 billion in the fourth quarter of For the twelve months ended December 31, 2008, $16.2 billion was paid or credited to policyholders compared to $11.2 billion in the twelve months ended December 31, The Standard Life transaction increased policy liabilities by $12.5 billion, partially offset by the initial cessions of the CLICC transaction and the U.S. branch recapture transaction in OTHER BENEFITS AND EXPENSES Included in other benefits and expenses are operating expenses, commission payments, financing charges, and premium taxes. Other benefits and expenses For the three months ended December 31 For the twelve months ended December % Change % Change Total expenses $ 158 $ 145 9% $ 563 $ % Less: investment expenses % % Operating expenses % % Commissions % Financing charges Premium taxes % % Total $ 317 $ 304 4% $ 1,146 $ 1,234-7% Operating expenses for the three months ended December 31, 2008 increased $12 million when compared to the same period in Expenses in local currencies were up only slightly. Commission payments remained unchanged and premium taxes increased $1 million from Operating expenses for the twelve months ended December 31, 2008 decreased $78 million when compared to the same period in The 2007 result includes a $97 million provision for a Canadian retirement plan. Financing charges include interest on debentures and other borrowings. INCOME TAXES Income taxes for the three and twelve month periods ended December 31, 2008 were $(20) million and $284 million, respectively, compared to $29 million and $76 million for the same periods in Net income before income taxes were $268 million and $1,316 million for the three and twelve month periods ended December 31, 2008, compared to $288 million and $840 million for the same period in The change in income tax is largely due to the resolution of prior year tax audits and the non-recurring impact of reduced Canadian income tax rates on the company s future tax balance in Canada Life Financial Corporation Annual Report 2008

13 MANAGEMENT S DISCUSSION AND ANALYSIS CONSOLIDATED FINANCIAL POSITION ASSETS Consolidated total assets December Shareholder Participating Total Shareholder Participating Total Assets Invested assets $ 40,265 $ 7,719 $ 47,984 $ 41,415 $ 7,808 $ 49,223 Goodwill and intangible assets Other general fund assets 12, ,117 2, ,486 Total general fund assets $ 53,601 $ 7,838 $ 61,439 $ 44,120 $ 7,934 $ 52,054 Segregated funds net assets 25,896 31,069 Total assets under administration $ 87,335 $ 83,123 Total assets under administration at December 31, 2008 were $87.3 billion, an increase of $4.2 billion from December 31, General fund assets increased by $9.4 billion and segregated funds assets decreased by $5.2 billion compared with December 31, Invested assets The Company manages its general fund assets to support the cash flow, liquidity and profitability requirements of the Company s insurance and investment products. The Company follows prudent and conservative investment policies, so that assets are not unduly exposed to concentration, credit or market risks. The Investment Division implements strategies within the overall framework of the Company s policies, reviewing and adjusting them on an ongoing basis in light of liability cash flows and capital market conditions. The majority of investments of the general fund are in mediumterm and long-term fixed-income investments, primarily bonds and mortgages, reflecting the characteristics of the Company s liabilities. Invested asset distribution December 31, 2008 December 31, 2007 Bonds Government bonds $ 12,060 25% $ 12,493 25% Corporate bonds 22, , Sub-total bonds 34, , Mortgages 6, , Stocks 1, ,838 4 Real estate 2, ,842 4 Sub-total portfolio investments 44, , Cash and cash equivalents 2, ,869 6 Policy loans Total invested assets $ 47, % $ 49, % Invested assets are recorded at fair value and at December 31, 2008 were $48.0 billion, a decrease of $1.2 billion from December 31, In general, growth in assets from organic business growth and acquisitions has been tempered by lower equity markets and higher credit spreads on stocks and bonds respectively. The distribution of assets has not changed materially and remains heavily weighted to bonds and mortgages. Canada Life Financial Corporation Annual Report

14 MANAGEMENT S DISCUSSION AND ANALYSIS Bond portfolio quality (excludes $821 million short-term investments, $695 million in 2007) December 31, 2008 December 31, 2007 Estimated rating AAA $ 13,367 40% $ 15,433 44% AA 6, , A 10, , BBB 3, ,816 8 BB or lower (1) Total $ 33, % $ 34, % (1) Excludes $125 million of bonds that were downgraded from investment grade to BB after December 31, Bond portfolio The total bond portfolio including short term investments decreased $1.1 billion to $34.5 billion or 72% of invested assets at December 31, 2008, from $35.6 billion or 72% of invested assets at December 31, 2007, mainly as a result of market value declines on bonds recorded at fair value. Federal, provincial Mortgage portfolio Mortgage loans by type Insured and other government securities represented 35% of the bond portfolio, in both 2008 and The overall quality of the bond portfolio remained high, with virtually all of the portfolio rated investment grade and 90% rated A or higher. December 31, 2008 December 31, 2007 Noninsured Total Total Single family residential $ 173 $ 15 $ 188 3% $ 176 3% Multi-family residential , , Commercial 187 4,913 5, , Total mortgages $ 1,106 $ 5,493 $ 6, % $ 6, % Mortgage portfolio The total mortgage portfolio increased to $6.6 billion or 14% of invested assets at December 31, 2008 compared to $6.2 billion or 12% of invested assets at December 31, Total insured loans were $1.1 billion or 17% of the mortgage portfolio. It is the Company s practice to acquire only high quality commercial loans meeting strict underwriting standards and diversification criteria. The Company has a well-defined risk rating system, which it uses in its underwriting and credit monitoring processes for commercial mortgages. Residential loans are originated by the Company s mortgage specialists in accordance with well-established underwriting standards and are welldiversified across each geographic region. Equity portfolio Equity portfolio by type December 31, 2008 December 31, 2007 Publicly traded stocks $ 1,259 33% $ 1,685 46% Privately held equity Real estate 2, , Total $ 3, % $ 3, % Equity portfolio The total equity portfolio was $3.8 billion or 8% of invested assets at December 31, 2008 compared to $3.7 billion or 8% of invested assets at December 31, The equity portfolio consists of public stocks, private equity and real estate. Publicly traded stocks decreased in 2008 due to equity market value declines and were offset by real estate acquisitions. 12 Canada Life Financial Corporation Annual Report 2008

15 MANAGEMENT S DISCUSSION AND ANALYSIS Asset quality general fund assets Non-investment grade bonds were $74 million or 0.2% of the bond portfolio at December 31, 2008 compared with $148 million or 0.4% of the portfolio at December 31, The net decrease in non-investment grade bonds resulted from repayments as well as a small number of changes in ratings. Impaired investments Gross Amount December 31, 2008 December 31, 2007 Other than temporary impairment Carrying amount Gross Amount Other than temporary impairment Impaired amounts by type Held for trading $ 82 $ (67) $ 15 $ $ $ Available for sale Loans and receivables 50 (26) (19) 10 Total $ 132 $ (93) $ 39 $ 29 $ (19) $ 10 Carrying amount Impaired investments, on a gross basis including bonds in default, mortgages in the process of foreclosure or in arrears 90 days or more, and real estate acquired by foreclosure, totaled $132 million at December 31, 2008 from $31 million at December 31, The increase includes investments related to certain issuers in the financial and auto sector and a large commercial mortgage in the U.K. The combination of the recognition of other than temporary impairments of $93 million ($19 million at December 31, 2007) and the $1,042 million at December 31, 2008 ($750 million at December 31, 2007) provision for future credit losses in actuarial liabilities represents 2.6% of bond, mortgage and real estate assets at December 31, 2008 (1.8% at December 31, 2007). Goodwill and intangible assets Goodwill and intangible assets were $7 million lower at December 31, 2008 compared to December 31, This was due to $1 million of amortization of intangible assets and $6 million of currency translation decreases. Refer to note 6 to the annual financial statements for more detail. Also refer to the Summary of Critical Accounting Estimates section of this document for details on impairment testing of these assets. Other general fund assets Other general fund assets December Funds held by ceding insurers $ 10,434 $ 2 Other assets 2,683 2,484 Total other general fund assets $ 13,117 $ 2,486 Other assets increased $199 million from 2007 to $2.7 billion in 2008 and is made up of several items including premiums in course of collection, interest due and accrued, fixed assets, prepaid amounts, and accounts receivable. The increase in funds held by ceding insurers reflects the closing of the Standard Life transaction in the first quarter of Segregated funds Segregated funds net assets December Stocks $ 18,903 $ 24,343 $ 25,245 Bonds 2,523 2,404 2,781 Real estate 1,323 1,861 2,068 Cash and other 3,147 2,461 1,815 Total $ 25,896 $ 31,069 $ 31,909 Year over year growth -17% -3% Segregated funds assets under management, which are measured at market values, decreased by $5.2 billion to $25.9 billion at December 31, The change resulted from realized and unrealized investment reductions of $6.3 billion partly offset by net deposits of $1.1 billion. Net market value and market reductions of $6.3 billion were comprised of market losses of $5.9 billion and unrealized currency translation losses of $0.4 billion. LIABILITIES Liabilities December Policy liabilities $ 52,446 $ 44,685 Deferred net realized gains Other general fund liabilities 3,525 2,551 Total liabilities $ 56,076 $ 47,350 Total liabilities have increased from $47.4 billion at December 31, 2007 to $56.1 billion at December 31, Policy liabilities Policy liabilities increased 17% to $52.4 billion at December 31, Actuarial liabilities are 97% of total policy liabilities. Actuarial liabilities represent the amounts which, together with estimated future premiums and investment income, will be sufficient to pay estimated future benefits, dividends, and expenses on policies in force. Actuarial liabilities are determined using generally accepted actuarial practices, according to standards established by the Canadian Institute of Actuaries. Actuarial liabilities increased by approximately $7.7 billion mainly due to the Standard Life transaction which increased actuarial liabilities by $12.5 billion, partly offset by reductions due to a decrease in the fair value of assets backing actuarial liabilities since January 1, Canada Life Financial Corporation Annual Report

16 MANAGEMENT S DISCUSSION AND ANALYSIS Assets supporting actuarial liabilities Participating Individual Insurance & Investment Products Group Insurance Europe/ Reinsurance United States Total December 31, 2008 Bonds $ 4,775 $ 6,196 $ 717 $ 16,016 $ 854 $ 28,558 Mortgage loans 1,017 2, , ,924 Stocks ,115 Real estate 72 1,803 1,875 Other , ,445 Total assets $ 7,153 $ 9,183 $ 1,151 $ 32,080 $ 1,350 $ 50,917 Total actuarial liabilities $ 7,153 $ 9,183 $ 1,151 $ 32,080 $ 1,350 $ 50,917 December 31, 2007 Bonds $ 4,305 $ 6,461 $ 714 $ 18,417 $ 926 $ 30,823 Mortgage loans 998 2, , ,818 Stocks ,441 Real estate 63 1,319 1,382 Other 1, , ,781 Total assets $ 7,181 $ 9,774 $ 1,177 $ 23,850 $ 1,263 $ 43,245 Total actuarial liabilities $ 7,181 $ 9,774 $ 1,177 $ 23,850 $ 1,263 $ 43,245 Other assets include: funds held by ceding insurers, loans to policyholders, cash and certificates of deposit, premiums in the course of collection, interest due and accrued, future income taxes, fixed assets, prepaid expenses, accounts receivable and accrued pension assets. Asset and liability cash flows are carefully matched within reasonable limits to minimize the financial effects of a shift in interest rates. This practice has been in effect for several years and has shielded the Company s financial position from interest rate volatility. The decrease in bonds in Europe/Reinsurance is mainly attributable to widening credit spreads and market declines. The increase in other assets is the result of the Standard Life transaction. Other general fund liabilities Other general fund liabilities December Debentures $ 500 $ 700 Funds held under reinsurance contracts Other liabilities 2,336 1,520 Total other general fund liabilities $ 3,525 $ 2,551 Total other general fund liabilities at December 31, 2008 were $3.5 billion, an increase from $2.6 billion at December 31, On December 11, 2008, Canada Life redeemed all $200 million principal amount of its 5.80% Debentures, Series A. The increase in funds held under reinsurance contracts results mainly from the novation of a health business reinsurance agreement from London Reinsurance Group, Inc. (LRG). Other liabilities at $2.3 billion include accounts payable, current and future income tax liabilities, and provisions for post-retirement benefits. CAPITAL TRUST SECURITIES AND DEBENTURES Canada Life Capital Trust (CLCT), a trust established by The Canada Life Assurance Company (Canada Life) in February 2002, issued $450 million of capital trust securities (CLiCS), the proceeds of which were used by CLCT to purchase Canada Life senior debentures in the amount of $450 million. The main features of the trust units are as follows: The $450 million of non-voting CLiCS consists of $300 million of non-voting CLiCS Series A and $150 million of non-voting CLiCS Series B. Each holder of the CLiCS Series A and CLiCS Series B is entitled to receive a semi-annual non-cumulative fixed cash distribution of $ and $ per CLiCS, respectively, and accordingly represents an annual yield of 6.679% and 7.529%, payable out of CLCT s net distributable funds. Subject to regulatory approval, CLCT may redeem the CLiCS, in whole or in part, at any time. At December 31, 2008, $416 million of the capital securities/trust units were held by external parties. 14 Canada Life Financial Corporation Annual Report 2008

17 MANAGEMENT S DISCUSSION AND ANALYSIS PARTICIPATING ACCOUNT SURPLUS AND SHAREHOLDER EQUITY Outstanding share data The Company s capital stock consists of common shares and preferred shares issued by the Company. At December 31, 2008 there were 160,530,331 common shares of the Company issued and outstanding with a stated value of $323 million, unchanged from December 31, The Company had 6,000, % Non-Cumulative Preferred Shares, Series B outstanding at December 31, 2008 with a principal amount of $150 million and a carrying amount of $145 million. The terms and conditions of the Series B shares do not allow the holder to convert to common shares of the Company or otherwise cause the Company to redeem the shares. Preferred shares of this type are commonly referred to as perpetual and represent a form of financing that does not have a fixed term. The Company regards the Series B shares as comprising part of its core or permanent capital. As such, the Company only intends to redeem the Series B shares with proceeds raised from new capital instruments issued during the life of the Series B shares, where the new capital instruments represent equal or greater equity benefit. The Company, at its option, may redeem the Series B shares. The Company had 8,000, % Cumulative Preferred Shares, Series C, outstanding at December 31, 2008 with a principal amount of $200 million. These shares are redeemable at the option of the Company for $25 per share together with all unpaid dividends activity During 2008, the Company paid preferred share dividends of $9 million. On December 5, 2008, the Company issued 8,000,000 Series C, 7.23% cumulative preferred shares to its parent, Great-West Life, for a value of $200 million or $25 per share. Changes in unrealized foreign exchange losses on translation of foreign operations of $(27) million and changes in other comprehensive income net of income taxes of $(30) million reduced shareholder surplus by $57 million from December 31, These activities, coupled with earnings from operations, resulted in total participating account surplus and shareholder equity of $4.9 billion at December 31, 2008, compared to $4.3 billion at December 31, LIQUIDITY AND CAPITAL MANAGEMENT AND ADEQUACY LIQUIDITY The Company s liquidity requirements are self-funded, with short term obligations being met by generating internal funds and maintaining adequate levels of liquid investments. At December 31, 2008, the Company held cash and liquid short term investments of $2.7 billion. In addition, the Company and its operating subsidiaries held Canada and United States and foreign government bonds of $11.3 billion. Funds provided by premiums and fees, investment income and maturities of investment assets are reasonably predictable and normally exceed liquidity requirements for payment of claims, benefits, and expenses. However, since the timing of available funds cannot always be matched precisely to commitments, imbalances may arise when demands for funds exceed those on hand. Also, a demand for funds may arise as a result of the Company taking advantage of current investment opportunities. The sources of the funds that may be required in such situations include bank financing and the issuance of debentures and equity securities. Liquid assets and other marketable securities December Liquid assets Cash, treasury bills and CDs $ 2,667 $ 3,228 Government bonds 11,264 12,127 Total liquid assets 13,931 15,355 Other marketable securities Corporate bonds 17,255 17,997 Common/Preferred shares (public) 1,258 1,685 Residential mortgages insured Total $ 33,363 $ 35,973 Cashable liability characteristics December Surrenderable insurance and annuity liabilities At market value $ 1,792 $ 2,285 At book value 7,800 7,610 Total $ 9,592 $ 9,895 The majority of the liquid assets and other marketable securities are comprised of fixed income securities whose value is inversely related to interest rates. Consequently, a significant rise in prevailing interest rates would result in a decrease in the value of this pool of liquid assets. As well, a high interest rate environment may prompt holders of certain types of policies to terminate their policies, thereby placing demands on the Company s liquidity position. The carrying value of the Company s liquid assets and other marketable securities is approximately $33.4 billion or 3.5 times the Company s expected total surrenderable insurance and annuity liabilities. The Company believes that it holds a sufficient amount of liquid assets to meet unanticipated cash flow requirements prior to their maturity. Canada Life Financial Corporation Annual Report

18 MANAGEMENT S DISCUSSION AND ANALYSIS CASH FLOWS For the three months ended December 31 For the twelve months ended December 31 Cash flows Cash flows relating to the following activities: Operations $ 571 $ 642 $ 1,938 $ 2,508 Financing (162) (71) (383) (3) Investment (868) (24) (2,340) (1,806) (459) 547 (785) 699 Effect of changes in exchange rates on cash and cash equivalents 30 (60) 15 (300) Increase (decrease) in cash and cash equivalents in the period (429) 487 (770) 399 Cash and cash equivalents, beginning of period 2,528 2,382 2,869 2,470 Cash and cash equivalents, end of period $ 2,099 $ 2,869 $ 2,099 $ 2,869 The principal source of funds for the Company is cash provided by operating activities, including premium income, net investment income and fee income. These funds are used primarily to pay policy benefits, policyholder dividends and claims, as well as operating expenses and commissions. Cash flows generated by operations are mainly invested to support future liability cash requirements. Financing activities include the issuance and repayment of capital instruments, and associated dividends and interest payments. In the quarter, cash and cash equivalents decreased by $429 million from September 30, Cash flows provided by operations decreased by $71 million compared to In 2008, cash flows were used by the Company to acquire an additional $868 million of investment assets (an increase of $844 million compared to 2007) and $150 million of cash was used to pay dividends to the preferred and common shareholders. During the fourth quarter, the Company repaid $200 million principal amount of the 5.80% subordinated debentures. Also, the Company issued preferred shares to its parent in the amount of $200 million, and loaned the proceeds back to the parent. For the twelve months ended December 31, 2008, cash flows provided by operations decreased $570 million to $1,938 million compared to Cash flows from operations were used to acquire an additional $2,340 million of invested assets. The Company utilized $521 million of cash flows generated from operations and financing activities to pay preferred and common shareholder dividends. Currency movement since December 31, 2007 increased reported cash and cash equivalents by $15 million. During 2008, the Company repaid $200 million principal amount of the 5.80% subordinated debentures. In addition, the Company issued preferred shares to its parent in the amount of $200 million, and loaned the proceeds back to the parent. COMMITMENTS/CONTRACTUAL OBLIGATIONS Commitments/contractual obligations At December 31, 2008 Total Payments due by period within 1 year 2 years 3 years 4 years 5 years 1) Long-term debt $ 500 $ $ $ $ $ $ 500 2) Operating leases office ) Purchase obligations ) Credit-related arrangements (a) Contractual commitments (b) Letters of credit (see note 4(b) below) 5) Pension Contributions Total contractual obligations $ 705 $ 110 $ 18 $ 16 $ 13 $ 9 $ 539 1) Long-term debt includes long-term financing used in the ongoing operations and capitalization of the Company. 2) Operating leases include office space and certain equipment used in the normal course of business. Lease payments are charged to operations over the period of use. 3) Purchase obligations are commitments to acquire goods and services, essentially related to information services. 4) (a) Contractual commitments are essentially commitments of investment transactions made in the normal course of operations in accordance with policies and guidelines that are to be disbursed upon fulfillment of certain contract conditions. (b) Letters of credit are written commitments provided by a bank. The total amount of LOC s issued are $885 million. Total LOC facilities are $885 million. Canada Life as applicant has provided LOCs relating to business activities conducted within the Canada Life group of companies in respect of the following: US$525 million issued to its U.S. branch as beneficiary, to allow Canada Life to receive statutory capital credit for life reinsurance liabilities ceded to Canada Life International Re Limited (decreased to US$515 million in February 2009). 117 million issued to Canada Life Ireland Holdings Limited (CLIHL) as beneficiary, to allow CLIHL to receive statutory capital credit in the United Kingdom for a loan made to The Canada Life Group (U.K.) Limited. US$14 million issued to a U.S. regulator as beneficiary on behalf of its U.S. branch, to receive statutory capital credit for certain reinsurance liabilities ceded to third party non-u.s. licensed reinsurers. 5) Pension contributions are subject to change, as contribution decisions are affected by many factors including market performance, regulatory requirements and management s ability to change funding policy. Funding estimates beyond 2009 are excluded due to the significant variability in the assumptions required to project the timing of future contributions. over 5 years 16 Canada Life Financial Corporation Annual Report 2008

19 MANAGEMENT S DISCUSSION AND ANALYSIS CAPITAL MANAGEMENT AND ADEQUACY The Company s practice is to maintain the capitalization of its regulated operating subsidiaries at a level that will exceed the relevant minimum regulatory capital requirements in the jurisdictions in which they operate. In Canada, the Office of the Superintendent of Financial Institutions (OSFI) has established a capital adequacy measurement for life insurance companies incorporated under the Insurance Companies Act (Canada) and their subsidiaries, known as the Minimum Continuing Capital and Surplus Requirements (MCCSR). The Company s MCCSR ratio at December 31, 2008 was 213% (224% at December 31, 2007). The Canada Life Assurance Company s MCCSR ratio at December 31, 2008 was 214% (226% at December 31, 2007). The capitalization of the Company and its operating subsidiaries will also take into account the views expressed by the various credit rating agencies that provide financial strength and other ratings to the Company. The Company is both a user and a provider of reinsurance, including both traditional reinsurance, which is undertaken primarily to mitigate against assumed insurance risks, and financial or finite reinsurance, under which the amount of insurance risk passed to the reinsurer or its reinsureds may be more limited. The Company has also established policies and procedures designed to identify, measure and report all material risks. Management is responsible for establishing capital management procedures for implementing and monitoring the capital plan. The Board of Directors reviews and approves all capital transactions undertaken by management pursuant to the annual capital plan. The capital plan is designed to ensure that the Company maintains adequate capital, taking into account the Company s strategy and business plans. RATINGS The Company and its major operating subsidiary continue to hold strong ratings. Rating Agency Measurement Rating A.M. Best Company Financial Strength A+ Dominion Bond Rating Service Claims Paying Ability Subordinated Debt IC-1 AA(low) Fitch Ratings Insurer Financial Strength AA+ Moody s Investors Service Insurance Financial Strength Aa3 Standard & Poor s Ratings Services Insurer Financial Strength Subordinated Debt AA AA- FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS Financial and other instruments held by the Company include portfolio investment, various derivative financial instruments, and debentures and other debt instruments. Portfolio investments consist of bonds, stocks, mortgage loans and real estate. Derivatives include Interest Rate Contracts (futures long, futures short, swaps, written options, purchased options), Foreign Exchange Contracts (forward contracts, cross currency swaps) and other derivative contracts (equity contracts, credit default swaps). Debentures and other debt instruments consist of short and long term financings due between one and nineteen years. Financial instrument carrying values currently reflect the illiquidity of the markets and the liquidity premiums embedded in the market pricing methods the Company relies upon. Fair values for bonds classified as held for trading or available for sale are determined using quoted market prices. Where prices are not quoted in a normally active market, fair values are determined by valuation models primarily using observable market data inputs. Market values for bonds and mortgages classified as loans and receivables are determined by discounting expected future cash flows using current market rates. Canada Life Financial Corporation Annual Report

20 MANAGEMENT S DISCUSSION AND ANALYSIS The following table summarizes the extent of our use of quoted market prices, valuation models with observable market data inputs and valuation models with significant non-observable market data inputs for our significant financial assets and liabilities carried at fair value December 31, Financial assets and liabilities carried at fair value by valuation methodology December 31, 2008 Fair value Quoted prices Observable inputs Valuation Models Non-observable inputs Financial assets Held for trading $ 30,058 96% 4% 100% Available for sale (1) 2,636 88% 12% 100% Derivatives % 100% 32,987 Financial liabilities Derivatives % 100% $ 535 Total (1) Excludes private equity classified as available for sale, carried at cost of $129 million. Fair values for public stocks are generally determined by the last bid price for the security from the exchange where it is principally traded. Fair values for stocks for which there is no active market are determined by discounting expected future cash flows. Where market value can not be measured reliably, fair value is estimated to be equal to cost. Market values for real estate are determined using independent appraisal services and include management adjustments for material changes in property cash flows, capital expenditures or general market conditions in the interim period between appraisals. Cash flows of assets supporting actuarial liabilities are matched within reasonable limits. Changes in the fair value of these assets are essentially offset by changes in the fair value of actuarial liabilities. Changes in the fair value of assets backing capital and surplus, less related income taxes, would result in a corresponding change in surplus over time, in accordance with investment policies. Refer to the Risk Management and Control Practices section of this report for a description of the risks and the management of risks related to financial instruments associated with actuarial liabilities. There were no major changes to the Corporation s and its subsidiaries policies and procedures with respect to the use of derivative instruments in During the twelve month period ended December 31, 2008, the outstanding notional amount of derivative contracts decreased by $636 million. The exposure to credit risk, which is limited to the current fair value of those instruments in a gain position, decreased to $293 million at December 31, 2008 from $498 million at December 31, For an overview of the use of derivative financial instruments, please refer to Note 21 of the 2008 Consolidated Financial Statements. 18 Canada Life Financial Corporation Annual Report 2008