Empire Life
Annual Report 2019

Plain-text annual report

The Empire Life Insurance Company Annual Report 2019 This page has been left blank intentionally. TABLE OF CONTENTS Financial Highlights Message from the Chairman of the Board Message from the President and Chief Executive Officer Sources of Earnings Management Discussion and Analysis Management's Responsibility for Financial Reporting Independent Auditor's Report Appointed Actuary's Report Consolidated Statements of Financial Position Consolidated Statements of Operations Consolidated Statements of Comprehensive Income Consolidated Statements of Changes in Equity Consolidated Statements of Cash Flows Notes to the Consolidated Financial Statements Intangible Assets Insurance Payables Insurance Receivables 1. Description of Company and Summary of Operations 2. Significant Accounting Policies 3. Financial Instruments 4. 5. Other Assets 6. Property and Equipment 7. 8. Segregated Funds 9. 10. Insurance Contract Liabilities and Reinsurance Assets/Liabilities 11. Accounts Payable and Other Liabilities 12. Employee Benefit Plans 13. Subordinated Debt 14. Insurance Premiums 15. Fee Income 16. Benefits and Expenses 17. Operating Expenses 18. Income Taxes 19. Earnings Per Share 20. Capital Stock 21. Dividends 22. Shareholders' Equity Entitlement 23. Segmented Information 24. Commitments and Contingencies 25. Related Party Transactions 26. Capital Management 27. Risk Management Glossary of Terms Participating Account Management Policy Participating Policyholder Dividends and Bonus Policy Participating Account Financial Disclosure Corporate Governance Over Risk Management Corporate Information Empire Life - Annual Report 2019 3 4 5 6 8 10 34 35 38 39 40 41 42 43 44 44 44 58 62 62 63 63 64 65 65 69 70 74 74 75 75 75 76 78 78 79 79 80 82 82 83 84 98 100 102 104 105 106 2019 FINANCIAL HIGHLIGHTS 155% LICAT total ratio as at December 31, 2019 Product diversification Strength of our capital base Product diversification Our Life Insurance Capital Adequacy Test (LICAT) ratio is well above the minimum requirements set by the industry regulator. A high LICAT ratio demonstrates our long-term ability to pay claims and our prudent capital management. What is an LICAT ratio? The LICAT is intended to measure the life insurer’s solvency position by recognizing the long-term economics of the life insurance business. OSFI has established supervisory target levels of 70% for Core and 100% for Total capital. by premium and fee income for the 12 months ended December 31, 2019 Empire Life is well-diversified across three product lines: Wealth Management 35% Employee Benefits 32% Individual Insurance 33% Financial ratings These financial ratings give you an independent opinion of our financial strength as an insurer and our ability to meet policyholder obligations. A (Excellent) A.M. Best Company (As at June 14, 2019) Financial Strength Rating: A Issuer Rating: A Subordinated Debt Rating: A (low) DBRS (as at May 27, 2019.) Note: The selected financial information presented above is derived from the audited financial statements of The Empire Life Insurance Company and Management’s Discussion and Analysis included in the Empire Life 2019 Annual Report. Common Shareholders’ Net Income 2019 (in millions) $174 Common Shareholders’ Net Income 2018 (in millions): $137 Net Premium and Fee Income 2019 (in millions) $1,172 Net Premium and Fee Income 2018 (in millions): $1,138 Total Assets Under Management 2019 (in millions) $18,100 Total Assets Under Management 2018 (in millions): $ 16,415 MESSAGE FROM THE CHAIRMAN OF THE BOARD There is a well-known saying: hindsight is 20/20. It means it's easy to know the right thing to do after something has happened, but it's hard to predict the future. To me, the mark of a truly successful company is one that doesn’t worry about predicting short-term events, but focuses on doing the right things for its customers over the long-term. As we enter a new decade in 2020, it is evident that the vision of Empire Life is clear and the company is doing all the right things to be competitive and relevant in an ever-changing industry. In May, the Board was given the opportunity to see first-hand some of the excellent work the teams are doing in the areas of digital and data to transform the business. The Board was very impressed with the passion with which team members talked about their work, and how they are developing and using technology to meet the changing preferences of consumers and to create a positive customer experience. Increasingly, Canadians are concerned about the use of their personal information. With the pervasive use of technology, companies need to be more vigilant than ever in protecting their customers’ information. For these reasons, data security and privacy have become a key area of focus, and the Board will continue to provide the necessary oversight to make sure the company is doing the right things to protect people’s privacy and personal information. The insurance industry continues to sail against the headwinds of the low interest rate environment, increasing regulation and geo-political threats never seen before. Within this larger context, it will be imperative for companies to practice sound expense management and continuously improve to achieve cost savings. In May, Scott Ewert and Patricia Volker joined our Board of Directors, bringing with them valuable financial and accounting expertise. After serving many years on the Board, Mark Taylor did not stand for re-election. On behalf of the Board, we thank Mark for always being a steady voice and guiding force in the growth and success of Empire Life during his lengthy service. It is indeed hard to predict what the next decade will bring, but this I know. Empire Life has always thrived by focusing on the right things, and most of all, by focusing on people. It is in this realm where the company shines, and I am confident the people of Empire Life will do their utmost to ensure it continues to be their greatest competitive advantage for decades to come. Duncan N. R. Jackman Chairman of the Board February 26, 2020 Empire Life - Annual Report 2019 5 MESSAGE FROM THE PRESIDENT AND CHIEF EXECUTIVE OFFICER As we move into a new decade, the life insurance industry continues to be impacted by four major trends: lower interest rates, demographic shift, digital technology, and increased regulation. The continuing lower interest rate environment has significant implications for life insurers. At this time last year, economists forecasted that rates would increase in 2019; that did not happen. While lower interest rates are good for consumer debt holders, they are not positive for insurers, like us, with large fixed income portfolios that benefit from higher yields. We rely on solid fixed income returns to build assets and fund guarantees within our products. Our Chief Investment Officer, Ian Hardacre, reminds us of the importance of separating the economy and the market. We’ve seen the longest economic expansion on record and it could be in the last phase of the cycle. But the path of markets is not linear, and markets are much more volatile-events such as conflict in the Middle East, global trade, Brexit and the post-Brexit transition, Coronavirus, and the looming U.S. presidential election have meant continued volatility. Equity markets are becoming more complex with the introduction of exchange-traded funds (ETFs) and other synthetic instruments. We continue to execute on our disciplined, value-oriented approach to managing our customers’ investments with a focus on downside protection. In fact, two of our funds celebrated significant anniversaries in 2019; 25 years for Empire Life Asset Allocation Fund and 50 years for the Empire Life Elite Equity Fund. Studies show that Canadians are living longer and their biggest fear is outliving their investments. The baby boomer generation are either retired or are in the process of preparing for retirement. Our Class Plus 3.0 investment product continues to be relevant because it provides guaranteed income for life. We are uniquely positioned to support our customers’ retirement income needs and grow our business. But it is also important that we address the needs of younger customers who are looking for the income and lifestyle protection that insurance products provide. We continue to build on our industry-leading digital capability that enables us to respond to younger digital native consumers. They want to buy easy to understand life and health insurance products online. We can deliver. We have been able to use digital technology to improve our customer service. We have automated our business processes. This has freed up customer support teams so they can answer customer questions. Over the past four years, we have reduced our average call answering time by 95%, down to just 13 seconds. We have also invested in developing our online portals so advisors and customers can access their data and our systems 24/7. With great power comes great responsibility; with digital progress comes an increased need to protect the data we are trusted with. Our customers count on us to responsibly manage and protect their information. We are constantly evaluating and strengthening our data security and privacy protection processes and systems to meet or exceed those expectations. The resources required to manage increasing regulation at international, federal and provincial levels continue to be of significant concern for insurers. We are facing far more aggressive consumer regulation and financial solvency regulation than in the past, much of which increases operating costs dramatically without any offsetting revenue gains. Nonetheless, it is a necessary part of our business. We are constantly measuring, monitoring and managing risk to ensure we manage our business responsibly. Business developments We are pleased to report that Empire Life was once again named Life and Health Insurer of the Year at the 2019 Insurance Business Canada Awards. This is the third time in the past four years we have been so honoured. We launched a new suite of six segregated funds combining passive and active management and added two new standalone funds to our Guaranteed Investments Funds (GIF) contract: the Empire Life Global Dividend Growth GIF and the Empire Life Short-Term High Income GIF. Our new multi-strategy GIFs provide exposure to ETFs and actively-managed investments from third-party managers within one segregated fund solution. We launched our interactive Retirement and Savings Tool which helps Canadians determine if they’re on track to meet their savings goals. For the fifth consecutive year, Empire Life segregated funds were recognized for their risk-adjusted performance, winning three Fundata FundGrade A+ Awards. Empire Life - Annual Report 2019 6 MESSAGE FROM THE PRESIDENT AND CHIEF EXECUTIVE OFFICER We added a new 10-pay option for our EstateMax® and Optimax Wealth® participating life insurance portfolios to offer consumers affordable, lifetime participating life insurance protection paid up in only 10 years. This product enables advisors to satisfy the needs of even more consumers looking for flexible, guaranteed lifetime protection. We added more functionality to our plan member and administrator portals. We also enhanced our direct billing offering through a partnership with providerConnect, a web portal that allows service providers in Canada to submit claims, accept payment or pay the patient, and view statements and claims reports online. Fighting fraud continues to be a focus for the group benefits industry and the Canadian Life and Health Insurance Association (CLHIA). In 2019, we created a new Find-a-Provider tool to help plan members find approved providers in their area for services like physiotherapy, massage and naturopathy. Not only does the tool make it simple, fast and easy for our plan members, but it also helps us mitigate benefits fraud, which affects our business results and, in turn, can increase costs for administrators and plan members. Financial results At year-end 2019, our Life Insurance Capital Adequacy Test (LICAT) ratio was 155%, exceeding all prescribed and recommended target levels. The LICAT is intended to improve the measurement of a life insurer’s solvency position by recognizing the long-term economics of the business. The Office of the Superintendent of Financial Institutions (OSFI) has established supervisory target levels of 70% for Core and 100% for Total LICAT capital. Our assets under management, including segregated funds, mutual funds, participating insurance policies and general assets, increased in 2019 to $18 billion, from $16 billion the previous year. Common shareholders’ net income increased to $174 million, compared to $137 million in 2018, resulting in earnings per share (basic and diluted) of $176.58 compared to $139.53 the previous year. These 2019 results were primarily due to significant changes in the Company's reinsurance program relative to unfavourable assumption updates and experience losses last year. Our results remain solid and reinforce our strategy of diversification across three lines of business. Net income for the individual life and health insurance product line was $65 million, up from $19 million in 2018. In the wealth management line, net income for 2019 was $74 million, up from $73 million in 2018. In our employee benefit product line, net income decreased to $7 million, down from $24 million in 2018. Our results in 2019 reflect our continued efforts in growing sales and adding new strategic partners building a solid foundation for future success. Our people and our purpose One thing that has remained constant over the last decade is our focus on helping Canadians build wealth and protect their financial security. Every member of our team understands that what we do every day makes a difference in the lives of our customers. It is our responsibility to be there when they need us most. As a company we are focused on continuous improvement. That means getting better at everything we do every day. In order to make this possible we must invest in our employees and enable them to increase their skills and embrace the future with optimism. Great teams accomplish great things. We were honoured to be named one of Forbes’ Best Employers in Canada in 2019, and again in 2020. We will continue our focus on being an employer of choice. Looking to the future Empire Life will celebrate its 100th anniversary in 2023. We will reach this milestone through the support of our advisors who trust us to provide our products and services to their clients. We appreciate their faith in us and will continue to work to serve our customers. Mark Sylvia President and Chief Executive Officer February 26, 2020 Empire Life - Annual Report 2019 7 SOURCES OF EARNINGS Source of earnings is a methodology for identifying and quantifying the various sources of International Financial Reporting Standards (IFRS) income of a life insurance company. It presents shareholders’ net income in a different format from the traditional income statement form and provides a better understanding of Empire Life’s sources of profit for each major product line. Expected Profit from In-Force Business This source of earnings represents the profit the Company expects to generate on in-force business if experience is in line with the Company’s best estimate assumptions for mortality, morbidity, persistency, investment returns, expenses and taxes. Impact of New Business Writing new business typically adds economic value to a life insurance company. However, as of the point of sale, new business may have a positive or negative impact on earnings. A negative impact (new business strain) will result when the assumptions used in determining the profits in the actuarial liabilities at the point of sale exceeds the expected profit margin assumed in the product pricing. The impact of new business also includes acquisition expenses not covered by product pricing at the point of issue. Experience Gains and Losses This item represents gains or losses due to the difference between actual experience and the best estimate assumptions. Possible areas of variances include benefit claims, policy persistency, expenses, investment income and others. Management Actions and Changes in Assumptions This component includes earnings generated by management actions during the year (e.g. acquisition or sale of a block of business, changes to product price, fees or asset mix, etc.) or the impact of changes in assumptions or methodology used for the calculation of actuarial liabilities for in-force business. Other This item includes any source of earnings from operations not included above. Earnings on Surplus This component represents the pre-tax earnings on the shareholders’ capital and surplus funds. Source of Earnings by Line of Business For the twelve months ended December 31 Wealth Management Employee Benefits Individual Insurance Capital and Surplus Total (in millions of dollars) 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 Expected profit on in-force business $ 113 $ 121 $ 25 $ 22 $ 52 $ Impact of new business Experience gains & losses Management actions and changes in assumptions Earnings on operations before income taxes Earnings on surplus Income before income tax Income taxes Shareholders' net income (12) 13 (16) 98 — (11) (17) (13) (9) (5) 97 — — 2 9 — 19 4 32 — 2 (19) 51 86 — 50 7 (14) (19) 24 — $ 190 $ 194 (28) (6) 37 194 54 (16) (3) (20) 154 37 — 54 — 37 $ $ 98 $ 97 $ 9 $ 32 $ 86 $ 24 $ 54 $ 37 $ 247 $ 191 24 24 2 8 19 1 15 7 60 40 74 $ 73 $ 7 $ 24 $ 67 $ 24 $ 39 $ 30 $ 187 $ 151 Empire Life - Annual Report 2019 8 SOURCES OF EARNINGS Wealth Management Wealth Management’s 2019 earnings on operations were generally consistent with the level achieved in 2018. Expected profit on in-force business was lower in 2019 due to lower fee income anticipated from a lower starting point for assets under management (AUM) in 2019 compared to 2018. The impact of new business was primarily driven by higher sales of fixed annuities partially offset by lower segregated fund and mutual fund sales. Experience gains in 2019 were primarily related to strong AUM growth in the segregated fund line fueled by strong equity market returns. Experience losses in 2019 were driven by low AUM growth on the segregated fund line combined with investment losses on the fixed annuity line. Losses from management actions and changes in assumptions were primarily driven by unfavourable assumption updates in the fixed annuities line in each of 2019 and 2018. Employee Benefits Employee Benefit’s earnings on operations were lower than the level achieved in 2018. Expected profit on in-force business was higher in 2019 due to the growth in the in-force block from strong sales activity in 2018. The impact of new business was higher than 2018 levels as a result of on-going growth in sales in this line. Experience gains and losses were nil in 2019, compared to 2018 where the line benefited from favourable health and disability claims results. Individual Insurance The increase in Individual Insurance earnings on operations was primarily due to the favourable impact of updates to policy liabilities related to changes in the Company's reinsurance programs, partially offset by more unfavourable updates for policy liability methodology and assumptions, higher experience losses and a less favourable impact of new business in 2019 relative to 2018. Capital & Surplus Earnings from Capital and Surplus in 2019 were higher than 2018 primarily from realized investment gains on assets held in this segment. Interest expenses were also lower level due to the redemption of some of the Company's subordinated debt in 2018. Empire Life - Annual Report 2019 9 MANAGEMENT'S DISCUSSION AND ANALYSIS Dated as of February 26, 2020 This document provides Management’s Discussion and Analysis (MD&A) of the operating results and financial condition of The Empire Life Insurance Company (Empire Life or the Company) for the years ended December 31, 2019 and 2018. This MD&A should be read in conjunction with the Company’s December 31, 2019 consolidated financial statements, which form part of The Empire Life Insurance Company 2019 Annual Report dated February 26, 2020. Unless otherwise noted, both the consolidated financial statements and this MD&A are expressed in Canadian dollars. Some variances may not reconcile and analysis of components may not sum to the analysis for the grouped components due to rounding. MD&A contains forward-looking information and involves numerous risks and uncertainties, including, but not limited to, those described in the “Risk Factors” section of the Annual Information Form which is available at www.sedar.com. No assurance can be given that results, performance or achievement expressed in or implied by any of the forward- looking information will occur, or, if they do, that any benefits may be derived from them. Actual results may differ materially from those expressed or implied by forward-looking information. See the Forward-Looking Statements and Information section in this report. The consolidated financial statements have been prepared in compliance with International Financial Reporting Standards (IFRS), which is generally accepted accounting principles as set out in the Handbook of the Chartered Professional Accountants of Canada. This MD&A makes reference to certain non-IFRS measures. These measures are not recognized measures under IFRS and do not have a standardized meaning prescribed by IFRS. They are therefore unlikely to be comparable to similar measures presented by other companies. Rather, these measures are provided as additional information to complement IFRS measures by providing further understanding of the Company’s results of operations from management’s perspective. Accordingly, they should not be considered in isolation nor as a substitute for analysis of the Company’s financial information under IFRS. See the Non-IFRS Measures section in this report. Note that certain comparative amounts have been reclassified and restated to conform with the presentation adopted in the current period. Financial Analysis Overview (in millions of dollars except per share amounts) Common shareholders' net income Earnings per share - basic and diluted Return on common shareholders' equity (quarterly annualized)¹ Fourth quarter $ $ 2019 76 77.25 18.7% $ $ 2018 6 6.36 1.7% $ $ Year 2019 174 176.58 11.1% $ $ 2018 137 139.53 9.4% Empire Life reported fourth quarter common shareholders’ net income of $76 million for 2019, compared to $6 million for 2018. In the fourth quarter of 2019, the Company enacted significant changes to its reinsurance program, which included an increase in the Company's individual life insurance retention level, along with a recapture of a significant amount of reinsured business. The net income impact of this reinsurance recapture initiative was $78 million. Full year common shareholders’ net income was $174 million compared to $137 million in 2018. The increase in earnings was primarily a result of the recapture initiative, partly offset by unfavourable assumption updates in the Wealth Management and Individual Insurance lines and a deterioration of long term disability (LTD) experience in the Employee Benefits line. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 10 MANAGEMENT'S DISCUSSION AND ANALYSIS The following table provides a breakdown of the sources of earnings for the fourth quarter and year. Sources of Earnings¹ (in millions of dollars) Expected profit on in-force business $ Impact of new business Experience gains (losses) Management actions and changes in assumptions Earnings on operations before income taxes Earnings on surplus Income before income tax Income taxes Shareholders' net income Dividends on preferred shares Common shareholders' net income Fourth quarter 2019 47 $ (7) 5 48 94 16 110 30 79 (3) 2018 51 $ (12) (26) (22) (9) 15 7 (3) 10 (3) $ 76 $ 6 $ Year 2019 190 $ (28) (6) 37 194 54 247 60 187 (13) 174 $ 2018 194 (16) (3) (20) 154 37 191 40 151 13 137 The expected profit on in-force business for the fourth quarter and for the year decreased by 8% and 2% respectively, due to lower than expected average assets under management in the Wealth Management line. The impact of new business for the fourth quarter was primarily driven by lower new business strain in the Wealth Management and Employee Benefits lines partially offset by higher strain in the Individual Insurance line. Lower sales of fixed annuities in the fourth quarter of 2019 relative to the fourth quarter of 2018 were the primary contributor to lower strain in the Wealth Management line. For the year, the impact of new business was higher than 2018 primarily due to higher strain in the Employee Benefits line as block transfers from new specialty partners were added in the first and second quarters of 2019. The experience gains for the fourth quarter of 2019 compared to losses in the fourth quarter of 2018 were mainly driven by lower investment losses in the Individual Insurance and Wealth Management lines. For the year, higher experience gains from strong growth in segregated fund assets were offset by higher experience losses in the Individual Insurance line from fixed income investments which contributed to higher overall experience losses in 2019 relative to 2018. Management actions and changes in assumptions in the fourth quarter of 2019 were higher than 2018 due to the favourable impact of the reinsurance recapture initiative. For the year, this favourable impact was partly offset by updates to methodology and assumptions on policy liabilities and by deterioration in LTD claims experience in 2019 relative to 2018. Earnings on surplus were higher for the year primarily due to realized gains on Available for sale (AFS) assets and lower interest expense as a result of a lower level of subordinated debt, partially offset by higher hedge costs. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 11 MANAGEMENT'S DISCUSSION AND ANALYSIS Selected Financial Information Income Statement Financial Information (in millions of dollars) Revenue Net premium income Fee income Investment income Realized gain on FVTPL investments Realized gain on AFS investments including impairment write downs Fair value change in FVTPL investments Total revenue Expenses Benefits and expenses Income and other taxes Total expenses Net income (loss) after tax Participating policyholders' portion Shareholders' net income Dividends on preferred shares Common shareholders' net income For the years ended December 31 2019 2018 2017 $ $ 910 262 326 105 22 490 2,115 $ 1,843 $ 81 1,924 191 3 187 13 174 $ $ $ $ 874 264 308 12 (1) (318) 1,138 931 60 991 148 (3) 151 13 137 $ 834 257 281 57 6 239 1,675 $ 1,425 74 1,499 176 (5) 181 10 171 $ $ Return on common shareholders' equity 11.1% 9.4% 12.8% Revenue volatility was driven primarily by the impact of market interest rate movements on the fair value change in fair value through profit or loss investments. The impact of these movements on net income is significantly reduced due to corresponding changes in insurance contract liabilities (included in Benefits and expenses in the above table). Balance Sheet Financial Information (in millions of dollars) Assets Total cash and investments Other assets Segregated fund assets Total assets Liabilities Insurance contract liabilities Reinsurance liabilities Subordinated debt Other liabilities Segregated fund policy liabilities Total liabilities Total equity Total liabilities and equity As at December 31 2019 2018 2017 $ $ $ 9,293 $ 8,278 $ 169 8,499 168 7,823 8,559 153 8,682 17,961 $ 16,270 $ 17,395 6,074 $ 5,176 $ 5,365 698 399 351 8,499 16,021 1,940 789 399 300 7,823 14,487 1,783 $ 17,961 $ 16,270 $ 651 698 278 8,682 15,674 1,721 17,395 1 See Non-IFRS Measures Empire Life - Annual Report 2019 12 MANAGEMENT'S DISCUSSION AND ANALYSIS Other Financial Information (in millions of dollars) Assets under management¹ General fund assets¹ Segregated fund assets¹ Mutual fund assets¹ Subordinated debt Preferred shares Available regulatory capital Tier 1 Tier 2 Total Surplus allowance and eligible deposits Base solvency buffer Required regulatory capital LICAT total ratio LICAT core ratio MCCSR ratio Cash dividends per share Preferred shares series 1 Preferred shares series 3 Common shares As at December 31 2019 2018 2017 $ 9,462 $ 8,447 $ 8,499 7,823 139 399 250 145 399 250 1,616 $ 1,476 $ 669 2,285 1,109 2,191 $ $ N/A 155% 109% N/A 653 2,129 887 2,029 N/A $ 149% 103% N/A 8,713 8,682 184 698 250 1,409 932 2,341 N/A N/A 831 N/A N/A 282% For the years ended December 31 2019 2018 2017 1.4375 1.2250 69.7632 $ $ $ 1.4375 1.2250 40.6060 $ $ $ 1.4375 0.2584 — $ $ $ $ $ $ Improvements to core and total capital were primarily driven by strong net income and strong growth in the Surplus allowance. The Surplus allowance reflects the value of conservative margins in the insurance contract liabilities. The Base solvency buffer increased due to overall growth in inforce business, as well as an increase related to the changes in the Company's reinsurance program. Effective January 1, 2018, Minimum Continuing Capital and Surplus Requirements (MCCSR) was replaced by the Life Insurance Capital Adequacy Test (LICAT). 1 See Non-IFRS Measures Empire Life - Annual Report 2019 13 MANAGEMENT'S DISCUSSION AND ANALYSIS Results by Major Product Line The following tables provide a summary of Empire Life results by major product line for the three months ended December 31 and year for 2019 and 2018. A discussion of results is provided in the Product Line section of the MD&A. For the three months ended December 31 Wealth Management Employee Benefits Individual Insurance Capital and Surplus Total (in millions of dollars) 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 Revenue Net premiums Investment income Fair value change in FVTPL investments Realized gain (loss) on FVTPL investments Realized gain (loss) on AFS investments including impairment write downs Fee income Total revenue Expenses Net benefits and claims Net change in insurance and investment contract liabilities Policy dividends Operating, commission and interest expenses Policy dividends Total expenses $ 35 $ 53 $ 93 $ 86 $ 101 $ 99 $ — $ — $ 229 $ 9 (6) 1 — 63 10 (18) — — 62 102 106 51 4 — 37 2 94 45 8 — 40 3 96 1 — — — 3 97 69 2 — 23 3 97 1 1 — — 3 91 60 3 — 22 3 88 57 (194) 53 (70) 17 — 60 — — 24 37 (147) 8 34 27 (42) (6) (2) — — 76 36 12 9 38 (4) 91 10 — 25 — — — 4 8 12 18 2 (1) (2) — 17 — — — 1 3 4 84 (200) 59 10 66 237 82 (86) (7) (1) 65 249 289 157 141 (141) 8 99 40 162 23 9 101 5 278 Net income (loss) after tax $ 8 $ 11 $ — $ 3 $ 66 $ (15) $ 13 $ 13 $ 87 $ 11 Participating policyholders' portion Dividends on preferred shares Common shareholders' net income 8 3 $ 76 $ 1 3 6 1 See Non-IFRS Measures Empire Life - Annual Report 2019 14 MANAGEMENT'S DISCUSSION AND ANALYSIS For the years ended December 31 Wealth Management Employee Benefits Individual Insurance Capital and Surplus Total (in millions of dollars) 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 $ 159 $ 155 $ 360 $ 340 $ 390 $ 379 $ — $ — $ 910 $ Revenue Net premiums Investment income Fair value change in FVTPL investments Realized gain (loss) on FVTPL investments Realized gain (loss) on AFS investments including impairment write downs Fee income Total revenue Expenses 40 18 1 — 249 467 39 (35) 1 — 253 412 5 4 — — 13 4 (1) — — 11 215 473 111 1 — 199 (279) 15 — — 382 354 1,190 314 Net benefits and claims 206 185 256 230 Net change in insurance and investment contract liabilities Policy dividends Operating, commission and interest expenses Income and other taxes Total expenses 18 — 144 24 393 (17) — 147 24 339 18 — 91 11 1 — 82 17 375 330 1,125 156 773 31 134 31 154 (34) 30 132 12 295 66 (5) (7) 21 — 76 — — — 16 16 32 66 (3) (4) (2) — 58 — — — 20 7 27 874 308 (318) 12 (1) 264 326 490 105 22 262 2,115 1,138 618 808 31 386 81 1,924 570 (50) 30 381 60 991 Net income (loss) after tax $ 74 $ 73 $ 7 $ 24 $ 65 $ 19 $ 44 $ 31 $ 191 $ 148 Participating policyholders' portion Dividends on preferred shares Common shareholders' net income 3 13 (3) 13 $ 174 $ 137 Total Revenue Net premiums for the fourth quarter were lower relative to the same period in 2018 primarily due to lower sales of fixed annuity products in the Wealth Management line. For the full year, net premiums were higher relative to 2018 reflecting growth in all product lines. Investment income for the year increased relative to 2018 primarily due to asset mix changes made in 2018 to incorporate higher yielding securities. Assets classified as Fair value through profit or loss (FVTPL) experienced a larger net loss in the fourth quarter relative to the same quarter in 2018 primarily due to increases in market interest rates during the fourth quarter of 2019. For the year, assets classified as FVTPL experienced a gain primarily due to decreases in market interest rates from their December 2018 values. For the same period in 2018, market interest rates increased, contributing to the net loss in assets valued as FVTPL. Fee income for the fourth quarter and the year increased by 2% and decreased by 1% respectively relative to the same period in 2018 primarily related to segregated fund management and guarantee fees from changes in assets under management. This is discussed in the Product Line Results - Wealth Management section later in this report. Total Expenses A substantial portion of the Net benefits and expenses changes are driven by the impact that market interest rate movements have on the net change in insurance contract liabilities. Net benefits and claims increased for the fourth quarter and the year by 11% and 8% respectively driven primarily by fixed annuities in the Wealth Management and higher health benefit claims in the Employee Benefits line. Net benefits and claims variability is dependent on claims incurred. Generally, claims rise year over year due to growth of the insurance blocks. Variability in claims amounts 1 See Non-IFRS Measures Empire Life - Annual Report 2019 15 MANAGEMENT'S DISCUSSION AND ANALYSIS does not, in isolation, impact net income as insurance contract liabilities are released when claims occur. The insurance contract liabilities released may be larger or smaller than the claims incurred depending on whether claims experience has been more or less than what was estimated for in the insurance contract liabilities. Claims experience is a combination of claims incurred compared to claims expected in product pricing and in insurance contract liabilities. Operating expenses, commissions and interest expenses decreased for the fourth quarter compared to 2018 primarily due to lower operating expenses in the Individual Insurance line. For the year, operating expenses, commissions and interest expenses were 1% higher than 2018 primarily due to higher operating expenses in the Employee Benefits line. Product Line Results - Wealth Management (in millions of dollars) Fixed Annuities Assets under management¹ Gross sales¹ Net sales¹ Segregated Funds Assets under management¹ Gross sales¹ Net sales¹ Fee income Mutual Funds Assets under management¹ Gross sales¹ Net sales¹ Fee income Fourth quarter 2019 2018 Year 2019 $ 958 $ 944 $ 958 $ 35 — 53 23 8,480 7,806 243 (83) 62 139 2 (7) — 244 (18) 61 145 2 (8) 1 159 13 8,480 856 (329) 246 139 8 (28) 2 2018 944 155 32 7,806 908 (118) 249 145 16 (27) 3 Net income after tax $ 8 $ 11 $ 74 $ 73 Fixed annuities assets under management increased by 1% during the last 12 months. Gross sales in the fourth quarter were 34% lower as customers shifted away from fixed income products. For the year, gross sales were 3% higher compared to 2018, reflecting strong sales in this segment during the first three quarters of the year. Segregated fund assets under management increased by 9% during the last 12 months primarily due an increase in stock markets during the first quarter after a significant decline in the fourth quarter of 2018. Gross sales in the fourth quarter were consistent with the fourth quarter of 2018 and lower for the full year primarily due to lower sales of traditional segregated fund products, partially offset by an increase in sales of the Guaranteed Minimum Withdrawal Benefit (GMWB) product. On October 23, 2019, Empire Life launched six new Multi-Strategy GIF segregated funds, to offer customers a mix of investment management styles and greater diversification. The Company also launched a new Short Term High Income GIF and reopened the Global Dividend Growth GIF. On November 12, 2018, Empire Life launched a new No Load purchase option within the GIF and Class Plus 3.0 product lines, and added four global fund options to Class Plus 3.0. The No Load option gives clients full access to their investments without any surrender charges. On May 28, 2018, Empire Life introduced seven new global funds, a fee for service option and a preferred pricing program to provide clients with more global and lower cost investment options within the GIF product line of segregated funds. Segregated fund fee income increased by 2% for the fourth quarter of 2019 and decreased by 1% for the full year primarily due to lower average assets under management relative to the same periods in 2018. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 16 MANAGEMENT'S DISCUSSION AND ANALYSIS Mutual fund assets under management decreased during the last 12 months due to lower mutual fund sales. Empire Life continues to explore various strategic alternatives with respect to its mutual fund business. Product Line Results - Employee Benefits (in millions of dollars) Selected financial information Annualized premium sales¹ Net premiums Net income (loss) after tax Fourth quarter 2019 2018 $ $ 21 $ 93 — $ 12 $ 86 3 $ 7 $ Year 2019 104 $ 360 2018 59 340 24 For the fourth quarter and year, annualized premium sales for Employee Benefits increased by 75% and 76% respectively, relative to 2018. This is primarily due to large block transfers from new strategic distribution partners in the first quarter of 2019, in addition to continued growth of the small to medium-sized business owner market. Over the last two years, Empire Life has entered into a number of strategic partnerships to expand market share. Net premiums for the fourth quarter and year increased by 8% and 6% respectively compared to the same period in 2018. Empire Life continues to focus on profitable sales in the employee benefits market where price competition continues for all major product lines. Net income declined in the fourth quarter of 2019 and full year relative to 2018 primarily due to a deterioration of long- term disability experience as the experience gains observed in 2018 did not recur. Product Line Results - Individual Insurance (in millions of dollars) Shareholders' Fourth quarter 2019 2018 Year 2019 2018 Shareholders' annualized premium sales¹ $ 5 $ 6 $ Shareholders' net premiums Benefits and Expenses Net income (loss) after tax Policyholders' Policyholders' annualized premium sales¹ Policyholders' net premiums Benefits and Expenses Net income (loss) after tax 69 (87) 62 5 32 19 4 69 59 (16) 5 29 36 1 21 $ 274 $ 916 67 18 116 178 (1) 23 278 173 24 16 101 109 (4) Net income (loss) after tax $ 66 $ (15) $ 65 $ 19 Shareholders' annualized premium sales declined for the fourth quarter and the year compared to 2018 primarily due to lower sales of term life products. Policyholders' annualized premium sales were consistent with the fourth quarter of the prior year and 13% higher for the full year from increased sales of the Company's participating life products. Shareholders' total net premiums in the fourth quarter was consistent with the same quarter in 2018 and 1% lower for the full year. Policyholders' net premiums were 10% and 15% higher for the fourth quarter and full year respectively, compared to 2018 primarily due to the stronger sales of the Company's participating life products in 2019. Shareholders' net income was higher for the fourth quarter and full year compared to 2018 primarily due to the impact of the reinsurance recapture initiative and mortality table update, partially offset by changes in net the net investment assumptions, as explained in more detail in the following table. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 17 MANAGEMENT'S DISCUSSION AND ANALYSIS (in millions of dollars) Components of pre-tax income increase from update of policy liability assumptions Year 2019 2018 Lapse/premium assumptions Net investment assumptions Mortality experience Mortality table update Reinsurance recapture Other $ (27) $ (120) 12 155 107 (69) Total gain (loss) from update of policy liability assumptions (excludes policyholders' portion) $ 57 $ (59) (3) 28 — — (3) (38) In 2019 the lapse/premium assumption change primarily related to updates of assumed lapse rates on renewable term policies. The refinement to lapse/premium assumptions for 2018 were primarily related to the adjustment of the lapse assumption on 10-year renewable term products and the enhancement of universal life lapse assumptions. The primary drivers of the net investment assumptions change for 2019 were decreases to the initial reinvestment rate (IRR) and ultimate reinvestment rate (URR) used in the valuation of liabilities. Updates were also made to the equity investment return assumption, the planned level of equities matching policy liabilities, and to the maturity assumptions for preferred shares. However, these items had a less significant impact when compared with the IRR and URR updates. In 2018 the change due to net investment assumptions was minimal. Updates to the mortality experience in 2019 were primarily related to revised projected assumptions for the individual life business. In 2018, mortality assumption changes included updates for mortality experience and a revised mortality improvement scale which is in line with the Canadian Institute of Actuaries promulgated mortality improvement scale. In 2019 the individual insurance mortality tables were replaced by more recent industry tables. The updated tables provide a more appropriate mortality projection, specifically at older ages. Actual/expected ratios were updated based on a combination of Company and industry experience. In 2019, the Company enacted significant changes to its reinsurance programs. Specifically, the reinsurers of the Company's individual life policies were notified that in 2020 the Company will increase its individual life retention from $500,000 to $1.5 million and the recapture provisions of all eligible reinsurance treaties would be enacted. The recapture resulted in a substantial net liability decrease on both the universal life and non-participating blocks of business as the present value of future reinsurance premiums was greater than the estimated future claims. Several model enhancements were implemented in 2019. These enhancements include updates to return of premium assumptions on universal life policies, reinsurance model refinements, and refinements to the mortality projection. Other policy liability updates for 2018 were primarily related to refinements to the modelling of reinsurance treaties. Results - Capital and Surplus (in millions of dollars) Net income (loss) after tax Net income (loss) after tax shareholders' portion Net income (loss) after tax policyholders' portion Net income (loss) after tax Fourth quarter 2019 2018 Year 2019 $ $ 10 $ 4 13 $ 12 $ — 13 $ 39 $ 5 44 $ 2018 30 1 31 In addition to the three major lines of business, Empire Life maintains distinct accounts for the investment income attributable to Shareholders’ Capital and Surplus and to Policyholders’ Surplus. Net income from the shareholders' portion of capital & surplus was lower than the fourth quarter of 2018 primarily due to a loss on hedging instruments in this portfolio relative to gains recorded in December 2018 from equity market 1 See Non-IFRS Measures Empire Life - Annual Report 2019 18 MANAGEMENT'S DISCUSSION AND ANALYSIS volatility, partially offset by higher realized gains on AFS assets. For the year, shareholders' net income was higher than 2018 primarily due to higher realized gains on AFS assets, positive fair value changes in FVTPL assets and lower interest expenses relative to 2018, partially offset by higher losses on hedging instruments. The interest expense for 2018 was higher prior to the redemption of $300 million subordinated debentures in May 2018. Shareholder Dividends The declaration and payment of common shareholder dividends and the amounts thereof are at the discretion of the Board of Directors. Common shareholder dividends are reviewed on a quarterly basis and will depend upon various factors, including the results of operations, the economic environment and the financial condition of Empire Life taking into account regulatory restrictions on the payment of shareholder dividends, as well as any other factors deemed relevant by the Board of Directors. The Board of Directors declared a dividend of $113.435853 per common share on February 26, 2020 to all common shareholders of record March 16, 2020 payable April 8, 2020. This dividend includes a regular quarterly dividend of $22.0724 and an additional dividend of $91.363453 per common share, which was enabled by the strong capital position of the Company at December 31, 2019. The following table provides details of the amounts and dates for Empire Life’s per share common and preferred share dividends. Common shares Non-Cumulative Rate Reset Preferred Shares, Series 1 (TSX: EML.PR.A) Non-Cumulative Rate Reset Preferred Shares, Series 3 Amount of Dividend per share Payable Date Record Date $ $ $ 113.435853 April 8, 2020 March 16, 2020 0.359375 0.306250 April 17, 2020 March 18, 2020 April 17, 2020 March 18, 2020 Empire Life advises that the above referenced dividends are eligible dividends for the purposes of the Income Tax Act, Canada and any similar provincial tax legislation. Total Cash Flow (in millions of dollars) Cash flow provided from (used for) Operating activities Investing activities Financing activities Net change in cash and cash equivalents Year 2019 368 $ (337) (96) (65) $ $ $ 2018 346 (68) (367) (89) Net change in cash and cash equivalents decreased by $65 million, made up of the following items: • The increase in cash provided from operating activities in 2019 relative to 2018 was primarily due to lower cash outflows related to changes in working capital levels. • The increase in cash used for investing activities in 2019 relative to 2018 was primarily due to management actions to deploy excess cash into higher yield investments in order to enhance investment income. • The decrease in cash used for financing activities in 2019 relative to 2018 was due to the redemption of $300 million subordinated debentures on May 31, 2018. For an analysis of liquidity for Empire Life, see note 10(e) and note 27(b) to the 2019 consolidated financial statements. Financial Instruments Empire Life buys investment quality bonds to support, to a very large extent, the liabilities under the insurance and annuity policies of Empire Life. Empire Life’s investment strategy also includes the use of publicly-listed common 1 See Non-IFRS Measures Empire Life - Annual Report 2019 19 MANAGEMENT'S DISCUSSION AND ANALYSIS stocks or exchange-traded funds (ETFs) to support the liabilities under its insurance policies. Cash flows arising from these financial instruments are intended to match the liquidity requirements of Empire Life’s policies, within the limits prescribed by Empire Life. Empire Life is subject to market risk on these financial instruments. Empire Life is also subject to credit risk on these financial instruments which could result in a financial loss should the other party fail to discharge an obligation. This credit risk is derived primarily from investments in bonds, debentures, preferred shares, short-term investments and mortgages. Empire Life manages market risk exposure mainly through investment limits and oversight of its in-house investment managers and external investment firms by the Chief Investment Officer, Asset Management Committee and Investment Committee of the Board. The Investment Committee actively monitors the portfolio size and asset mix. Empire Life has a semi-static hedging program as part of its approach to managing this risk. Empire Life manages credit risk by applying its investment guidelines established by the Investment Committee of the Board of Directors. The investment guidelines establish minimum credit ratings for issuers of bonds, debentures and preferred share investments, and provide for concentration limits by issuer of such debt instruments. Management reviews credit quality relative to investment purchases and also monitor the credit quality of invested assets over time. Management reports regularly to the Investment Committee of Empire Life’s Board on the credit risk to which the portfolio is exposed. Empire Life manages credit risk with respect to derivatives by applying limits and credit rating restrictions established by the Investment Committee in its investment guidelines, which set out permitted derivatives and permitted uses for derivatives, as well as limits to the use of these instruments. In particular, no leverage is permitted in the use of derivatives and strict counterparty credit restrictions are imposed. Additional information regarding financial instruments is included in notes 2(d), 3, 10(c), and 27 to the audited consolidated financial statements for the year ended December 31, 2019. Sources of Capital Empire Life has issued private and public securities to strengthen its capital position and fund new business growth. The securities outstanding are summarized in the following table. (in millions of dollars) Subordinated debentures Equity Preferred shares Common shares Total Equity As at December 31, 2019 December 31, 2018 $ $ $ $ 400 250 1 251 400 $ 250 $ 1 $ 251 $ As at December 31, 2019 December 31, 2018 $ $ 150 $ 100 $ As at 150 100 Details of the Company’s outstanding preferred shares and subordinated debt are as follows: Preferred Shares (in millions of dollars) Date Issued Earliest Redemption Date Preferred shares Preferred shares January 2016 April 17, 2021 November 2017 January 17, 2023 Yield 5.75% 4.90% (in millions of dollars) Date Issued Earliest Redemption Date Yield December 31, 2019 December 31, 2018 Subordinated debentures(a) Subordinated debentures(b) 200 (a) Series 2016-1 Subordinated 3.383% Unsecured Debentures due 2026. From December 16, 2021, interest is payable at 1.95% over the 3-month Canadian Deposit Offering Rate (CDOR). (b) Series 2017-1 Subordinated 3.664% Unsecured Debentures due 2028. From March 15, 2023, interest is payable at 1.53% over CDOR. December 16, 2021 September 2017 December 2016 200 $ 200 $ March 15, 2023 3.383% 3.664% 200 $ $ Empire Life’s debentures and preferred shares are rated by DBRS Limited (DBRS) and A.M. Best Company, Inc. (A.M. Best). Empire Life’s DBRS issuer rating is “A”, its subordinated debt rating is “A (low)”, its financial strength 1 See Non-IFRS Measures Empire Life - Annual Report 2019 20 MANAGEMENT'S DISCUSSION AND ANALYSIS rating is “A” and its Preferred Share rating is Pfd-2. All ratings have a stable trend. According to DBRS, the assigned ratings reflect Empire Life’s position as a consistently performing life insurer with a proven track record of generating stable earnings while maintaining a conservative risk profile. A.M. Best ratings of Empire Life are “A Excellent” financial strength rating, “a” long-term issuer credit rating, “bbb+” Subordinated Debt rating, and “bbb” Preferred Share rating. All ratings have a stable trend. According to A.M. Best, the ratings reflect Empire Life's balance sheet strength, which A.M. Best categorizes as very strong, as well as its strong operating performance, neutral business profile and appropriate enterprise risk management. Regulatory Capital The Life Insurance Capital Adequacy Test (LICAT) is intended to improve the measurement of the life insurer's solvency position by recognizing the long-term economics of the life insurance business. The Company continues to have a strong capital position under the LICAT framework. Empire Life is required to maintain a minimum Core Ratio of 55% and a Total Ratio of 90%. OSFI has established supervisory target levels of 70% for Core and 100% for Total capital. LICAT (in millions of dollars) Available capital Tier 1 Tier 2 Total Surplus allowance and eligible deposits Base solvency buffer LICAT total ratio LICAT core ratio Other Comprehensive Income (in millions of dollars) OCI, attributable to shareholders OCI, attributable to policyholders Total other comprehensive income Dec 31 2019 Sep 30 2019 Jun 30 2019 Mar 31 2019 Dec 31 2018 $ $ 1,616 $ 1,562 $ 1,549 $ 1,507 $ 669 681 674 692 2,285 $ 2,243 $ 2,223 $ 2,200 $ 1,109 2,191 155% 109% 944 2,133 149% 104% 937 2,115 149% 104% 921 2,083 150% 103% Fourth quarter 2019 2018 $ $ (16) $ (4) $ (20) $ (7) $ (3) (10) $ Year 2019 48 $ 1 49 $ 1,476 653 2,129 887 2,029 149% 103% 2018 (28) (4) (32) Other comprehensive income (OCI) decreased in the fourth quarter primarily due to unrealized fair value losses on AFS investments compared to a small gain in the fourth quarter of 2018 partially offset by a gain on remeasurement of post-employment benefit liabilities. For the year, OCI increased relative to 2018 primarily due to unrealized fair value gains on AFS assets in 2019 relative to unrealized fair value losses on AFS assets in 2018, and a lower loss on remeasurement of the liability component of post-employment DB plans relative to 2018. Remeasurement of defined benefit pension plans does not immediately impact LICAT as each quarter’s remeasurement gain or loss is amortized over twelve quarters for LICAT purposes. Industry Dynamics and Management’s Strategy Empire Life’s operations are organized by product line with each line of business having responsibility for product development, product pricing, marketing, distribution and customer service within their particular markets. This structure recognizes that there are distinct marketplace dynamics in each of the three major product lines. Management believes this structure enables each line of business to develop strategies to achieve the enterprise- wide objectives of business growth and expense management while recognizing the unique business environment in which each operates. The lines of business are supported by corporate units that provide administrative and 1 See Non-IFRS Measures Empire Life - Annual Report 2019 21 MANAGEMENT'S DISCUSSION AND ANALYSIS technology services to the lines of business, manage invested assets, and oversee enterprise risk management policies. Based on general fund and segregated fund assets, Empire Life is among the 10 largest life insurance companies in Canada. Empire Life has approximately 7% market share of segregated funds, 1% market share for employee benefits and 2% market share for new life insurance premiums. To be priced competitively in the marketplace while simultaneously providing acceptable long-term financial contribution to shareholders, Empire Life, as a mid-sized company, must find a way to continue to be cost competitive with the larger companies that have some natural economy of scale advantages. In order to improve its unit expenses, management’s enterprise-wide strategic focus has been on achieving profitable growth in its selected markets and on expense management. Empire Life has focused exclusively on the Canadian marketplace and, within it, on particular market segments where management feels there are opportunities to build solid, long-term relationships with its distribution partners by offering competitive products and more personal service. By focusing on particular market segments and by being seen by these independent advisors as a viable alternative to broadly focused competitors, management believes these solid relationships will enable profitable growth. In 2019, the Company acquired a minority interest in The Gryphin Advantage Inc. as part of its continuing commitment to ensuring consumers have the availability of independent advice in the marketplace. The Wealth Management product line at Empire Life is comprised of segregated fund products, guaranteed interest products and mutual funds. These products compete against products offered by a variety of financial institutions. A key element of any competitive strategy in this market is providing a competitive rate of return to clients. The value- oriented equity investment strategy used by Empire Life has focused on developing long-term performance in the fund marketplace. Management will continue to improve competitiveness by focusing on long-term performance, providing low cost products to customers along with broadened distribution reach. Empire Life continued to achieve strong growth in assets under management from its segregated fund business as a result of net new sales and equity market appreciation. Empire Life is continuing to monitor and manage GMWB risk exposure and the competitive landscape for this product. Within the broader employee benefits marketplace in Canada, Empire Life continues to focus on the small group employer market with fewer than 200 employees representing the majority of Canadian companies. This niche strategy coupled with an ongoing focus on balancing growth and profit has enabled Empire Life to be cost competitive within this market segment and is expected to enable this product line to grow its market share while generating acceptable returns. Individual Insurance products are very long-term in nature and consequently can be subject to new business strain. New business strain occurs when the provision for adverse deviation included in the actuarial policy liabilities exceeds the profit margin in the product pricing. At current reinsurance price levels in the Canadian market place, a company may reduce new business strain and improve profitability in the short term by opting to increase the amount of insurance risk reinsured to third parties. Mortality trends continue to be favourable for life insurance products. Rather than give up the future earnings that would emerge if the trend in mortality improvement witnessed in recent decades continues, Empire Life continues to utilize lower than average levels of reinsurance with the resultant negative impact on short-term earnings. Low long-term interest rates continue to have an unfavourable impact on this product line. In the past few years, industry prices for longer term life insurance products have increased. Empire Life has also increased prices for these products and has focused its growth efforts on shorter term products, such as 10 year renewable term life insurance. Because of the reasonable long-term returns of this product line, management continues to focus on steady growth, technology development and process improvement in order to continue to have a cost structure that allows us to compete while generating an acceptable long-term financial contribution. Empire Life is continuously reviewing its Individual Insurance product mix to improve profitability, reduce interest rate risk, reduce required regulatory capital, develop web-based products and processes, and improve the customer and advisor experience. Risk Management Empire Life is a financial institution offering wealth management, employee benefits and individual insurance products. The Company is exposed to a number of risks as a result of its business activities. The goal of the Company’s risk management process is to ensure that the operations that expose it to risk are consistent with its 1 See Non-IFRS Measures Empire Life - Annual Report 2019 22 MANAGEMENT'S DISCUSSION AND ANALYSIS strategy, business objectives and risk philosophy, while maintaining an appropriate risk/reward balance and enhancing stakeholder value. When making decisions about risk taking and risk management, Empire Life considers: • The need to meet the expectations of its customers, shareholders and creditors and to protect the commitments that have been made to them; • The need to be adequately compensated for the capital it deploys to support business activities and strategic objectives; • The need to protect its brand; and • The need to maintain (or improve) its targeted financial strength rating. Empire Life’s risk appetite defines the aggregate level of risk the Company is willing to take to achieve its business strategies. The risk appetite supports the pursuit of shareholder value but does not compromise the Company’s ability to pay claims and fulfil policyholder commitments. Empire Life’s risk management framework is structured based on a number of guiding principles: • Due to the long term nature of the majority of its commitments, the Company accepts capital market risk provided it is managed within specific risk tolerances and limits. The Company takes a low-risk, value- oriented approach to managing its investments - it accepts credit and alternative asset risk provided it is rewarded through appropriately enhanced returns; • The Company manages liquidity across the business to provide a high level of confidence that all obligations (to customers, creditors and shareholders) will be met when they fall due; • The Company accepts insurance risks provided they are properly priced and managed in order to deliver value to its customers and shareholders; • The Company is forward-looking in its business planning and takes a prudent approach to capital management. It strives to have a high level of confidence that capital is sufficient to support planned future activities; • Management is active in industry committees and, through a network of oversight functions, monitors the landscape so that the Company is appropriately positioned to manage regulatory, tax, accounting and actuarial changes; • The Company accepts that operational risks are a part of doing business and knows that risk management is a key part of decision-making. It protects its business and customers by engaging in cost-effective risk mitigation; and • The Company expects ethical conduct by all of its employees and it acts with integrity at all times. The Board of Directors oversees and monitors Empire Life’s risk management framework, processes and practices, and reviews and approves the Company’s Enterprise Risk Management Framework and overall risk appetite. Senior management shares responsibility and accountability for risk management across the organization. This enables a cross-functional perspective on risk management, enhanced by the frequency of contact across the management team. The Company has an Asset Management Committee with responsibility for overseeing the management of corporate policies established by both the Investment Committee and Risk and Capital Committee of the Board, with specific focus on market, credit and liquidity risk including asset/liability management as well as capital management. The Product Management Review Committee is responsible for overseeing management of corporate policy established by the Risk and Capital Committee of the Board, with specific focus on insurance. Activities not delegated to one of these two committees remain under the oversight of senior management. More information related to governance can be found under the Corporate Governance over Risk Management section of Empire Life’s 2019 Annual Report. Risk management policy development is centralized under the leadership of the Chief Risk Officer and applies to all business units. The Chief Risk Officer is a member of the Asset Management Committee and Product Management Review Committee and has Board reporting responsibility with respect to risk and capital management. All risk management policies and procedures are regularly reviewed for relevance and changes in the risk environment. Accountability, application, day-to-day management and procedural elements are the responsibility of area management, supported by business unit compliance officers and the risk management department. There is senior management representation and oversight on various interdisciplinary risk control committees. The Company formally establishes and documents its values and risk tolerances through several company-wide policies including a code of business conduct, corporate disclosure principles, enterprise risk management, capital management and whistleblower policies. The Company’s strategic risk management policies (including those related to product design and pricing, investment and capital management) are also approved by its Board, or a Board committee. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 23 MANAGEMENT'S DISCUSSION AND ANALYSIS Caution Related to Sensitivities In the sections that follow, Empire Life provides sensitivities and risk exposure measures for certain risks. These include sensitivities due to specific changes in market prices and interest rates, based on market prices, interest rates, assets, liabilities and business mix in place as at the calculation dates. The sensitivities are calculated independently for each risk factor, assuming that all other risk variables remain constant. Actual results can differ materially from these estimates for a variety of reasons, including the interaction among these factors when more than one factor changes; changes in actuarial and investment return and future investment activity assumptions; actual experience differing from the assumptions; changes in business mix, effective tax rates and other market factors; and the general limitations of Empire Life’s internal models used for purposes of these calculations. Changes due to new sales or maturities, asset purchases/sales, or other management actions could also result in material changes to these reported sensitivities. For these reasons, the sensitivities should only be viewed as directional estimates of the underlying sensitivities for the respective factors based on the assumptions outlined, and should not be viewed as predictors for Empire Life’s future net income, OCI, and capital sensitivities. Given the nature of these calculations, Empire Life cannot provide assurance that actual impact will be consistent with the estimates provided. Changes in risk variables in excess of the ranges illustrated may result in other than proportionate impacts. Market Risk Empire Life has equity market risk related to its segregated fund products and from equity assets backing life insurance liabilities. Empire Life has a semi-static hedging program. The hedging program may employ derivatives positions including put options and futures. The extent of derivatives used is monitored and managed on an ongoing basis, giving consideration to equity risk and the level of available capital. There is income statement volatility from this hedging program. Based on current equity market levels, Empire Life has required capital for LICAT purposes and policy liabilities on the statement of financial position related to segregated fund guarantees. Therefore a by-product of hedging LICAT exposure is net income volatility, as the gains or losses from hedging instruments are not necessarily offset by changes in policy liabilities related to segregated fund guarantee risk. During the fourth quarter and for the year, Empire Life experienced a loss of $2 million and $11 million after tax respectively on its hedging program primarily due to rising Canadian stock indices. This compares to a hedging program gain of $6 million and $2 million respectively for the comparable periods in 2018 primarily due to a decline in Canadian stock prices in December 2018. Empire Life’s LICAT ratio is also sensitive to stock market volatility, due primarily to liability and capital requirements related to segregated fund guarantees. As of December 31, 2019, Empire Life had $8.5 billion of segregated fund assets and liabilities. Of this amount, approximately $8.2 billion have guarantees. The following table provides a percentage breakdown by type of guarantee. Percentage of Segregated Fund Liabilities with: 75% maturity guarantee and a 75% death benefit guarantee 75% maturity guarantee and a 100% death benefit guarantee 100% maturity and death benefit guarantee (with a minimum of 15 years between deposit and maturity date) Guaranteed minimum withdrawal benefit (GMWB) Dec 31 2019 Dec 31 2018 4% 46% 7% 43% 3% 47% 7% 43% All Empire Life segregated fund guarantees are policy-based (not deposit-based), thereby generally lowering Empire Life’s stock market sensitivity relative to products with deposit-based guarantees. Policy-based guarantees consider all of the deposits in the customer’s policy (whether the fund value is below or above the guaranteed amount) to arrive at an overall net guarantee payment, whereas deposit-based guarantees consider only the deposits where the fund value is below the guaranteed amount and ignore all the deposits in the customer’s policy where the fund value is above the guaranteed amount. Therefore, policy-based guarantees generally pay less than deposit-based guarantees. For segregated fund guarantee insurance contract liabilities, the level of sensitivity is highly dependent on the level of the stock market at the time of performing the estimate. If period-end stock markets are high relative to market levels at the time that segregated fund policies are issued, the sensitivity is reduced. If period-end stock 1 See Non-IFRS Measures Empire Life - Annual Report 2019 24 MANAGEMENT'S DISCUSSION AND ANALYSIS markets are low relative to market levels at the time that segregated fund policies are issued, the sensitivity is increased. The segregated fund regulatory capital and liability framework includes the use of "zero floors" (i.e., negative liability amounts are not permitted so zero is used instead, as described below) and other regulatory constraints, and this often makes the sensitivity impacts non-linear. The liabilities are the greater of: (i) the average of the amounts determined by averaging the results from adverse economic scenarios; and (ii) zero. Empire Life also has equity market risk related to its equity assets backing life insurance liabilities. Based on stock market levels as at December 31, 2019 and December 31, 2018, the sensitivity of Empire Life shareholders’ net income and LICAT ratio resulting from stock market increases and decreases is provided in the following table. Sensitivity to equity risk: Increase Decrease Impact on net income (in millions of dollars after tax) 20% 10% 10% 20% 30% as at December 31, 2019 Segregated fund guarantees Other equity risk Equity hedge Total as at December 31, 2018 Segregated fund guarantees Other equity risk Equity hedge Total Sensitivity to equity risk: Impact on LICAT as at December 31, 2019 Segregated fund guarantees Other equity risk Equity hedge Total as at December 31, 2018 Segregated fund guarantees Other equity risk Equity hedge Total $ $ $ $ — $ — $ (10) $ (76) $ (229) 33 (2) 15 (1) (12) 4 (20) 16 (65) 38 31 $ 14 $ (18) $ (80) $ (256) 3 $ 3 $ (11) $ (129) $ (269) 38 (6) 18 (4) (15) 9 (46) 26 (118) 50 35 $ 16 $ (16) $ (150) $ (337) Increase Decrease 20 % 10 % 10 % 20 % 30 % 3 % (1)% (3)% (1)% 3 % — % (2)% 1 % — % (1)% (2)% (2)% — % (1)% (1)% (1)% (6)% — % 1 % (4)% (16)% (22)% 1 % 3 % 1 % 3 % (12)% (18)% (10)% (16)% (22)% — % 1 % (9)% — % 2 % (2)% 3 % (14)% (21)% Empire Life's equity market sensitivity for segregated fund guarantees in a 20% and 30% stock market decline decreased primarily as a result of improved equity markets during the 2019. The segregated fund guarantee liability became positive at December 31, 2018 after an equity market decline in the fourth quarter. This increased net income sensitivity as any changes to the liability when it is above a zero floor will flow through net income. In 2019, the Company updated the methodology for calculating equity risk sensitivities. The new method refines the assumptions used in calculating the baseline LICAT equity requirements as at the reporting date. In the table above, 1 See Non-IFRS Measures Empire Life - Annual Report 2019 25 MANAGEMENT'S DISCUSSION AND ANALYSIS figures presented for the impact of equity risk on LICAT as at December 31, 2018 are restated to conform with the updated methodology. The amount at risk related to segregated fund maturity guarantees and segregated fund death benefit guarantees, and the resulting policy liabilities and LICAT base solvency buffer for Empire Life’s segregated funds is provided in the following table. Segregated Funds Withdrawal Benefit > Fund Value Maturity Guarantee > Fund Value Death Benefit > Fund Value (in millions of dollars) Fund Value Amount At Risk Fund Value Amount At Risk Fund Value Amount At Risk Policy Liabilities LICAT Capital December 31, 2019 December 31, 2018 $ $ 2,701 $ 2,689 $ 882 $ 1,057 $ 51 $ 301 $ 2 $ 24 $ 650 $ 3,789 $ 6 $ 165 $ — $ 4 $ 465 433 The first six columns of the above table show all segregated fund policies where the future withdrawal benefit, future maturity guarantee, or future death benefit guarantee is greater than the fund value. The amount at risk represents the excess of the future withdrawal benefit, future maturity guarantee or future death benefit guarantee amount over the fund value for these policies. The withdrawal benefit amounts in the above table relate to GMWB products. The GMWB withdrawal benefit amount at risk represents the amount that could be paid by Empire Life to GMWB policyholders if the net return on each GMWB policyholder’s assets is zero for the remainder of each GMWB policyholder’s life, based on life expectancy. As at December 31, 2019, the aggregate amount at risk for all three categories of risk was $890 million. At December 31, 2018, the aggregate amount at risk for these three categories of risk was $1,246 million. For these three categories of risk, the amount at risk is not currently payable. Payment is contingent on future outcomes, including fund performance, deaths, deposits, withdrawals and maturity dates. The level of policy liabilities and required regulatory capital in the above table is calculated based on the probability that Empire Life will ultimately have to make payment to the segregated fund policyholders for any fund value deficiency that may exist on future payments to GMWB policyholders, or upon future maturity of the segregated fund policies, or upon future death of the segregated fund policyholders. In addition, Empire Life considers the sensitivity of its LICAT ratio to changes in market interest rates. The impact of an immediate 50 basis point decrease in interest rates and a 50 basis point decrease in assumed initial reinvestment rate (IRR) for non-participating insurance business and segregated fund guarantees for December 31, 2019 and December 31, 2018, is shown in the table below. This assumes no change in the ultimate reinvestment rate (URR). The AFS bonds provide a natural economic offset to the interest rate risk attributable to Empire Life’s product liabilities. Sensitivity to Market Interest Rates LICAT December 31, 2019 LICAT total ratio December 31, 2018 LICAT total ratio Impact of 50 bps Decrease 1 % (5)% Operational Risk Operational risk relates to the uncertainty arising from larger than expected losses or damages as a result of inadequate or failed internal processes, people and systems, or from external events. Operational risk is naturally present in all of Empire Life’s business activities and encompasses a broad range of risks, including legal disputes, regulatory compliance failures, technology failures, business interruption, information security and privacy breaches, human resources management failures, processing errors, modelling errors, theft and fraud, and damage to physical assets. If not managed effective, operational risk can impact Empire Life's ability to manage other risks. The following is a further description of some operational risks and their associated risk management strategies. (1) Legal and Regulatory Compliance Risk Empire Life is governed by the Insurance Companies Act and supervised by OSFI and is also subject to various requirements imposed by legislation and regulation in each of the provinces and territories of Canada applicable to 1 See Non-IFRS Measures Empire Life - Annual Report 2019 26 MANAGEMENT'S DISCUSSION AND ANALYSIS insurance companies and companies providing other financial services. Material changes in the regulatory framework could have an adverse effect on Empire Life. Failure to comply with regulatory requirements or public expectations could adversely impact Empire Life’s reputation and ability to conduct business. Empire Life is subject to litigation from time to time, in the normal course of business, and currently has a number of outstanding lawsuits. There can be no assurance that the present or any future litigation will not have a material adverse effect on Empire Life. Empire Life’s corporate compliance department, headed by the Chief Compliance Officer, oversees the regulatory compliance framework. This framework promotes risk-based management of regulatory compliance risk and includes Company-wide policies, operating guidelines, programs to promote awareness of laws and regulations impacting Empire Life, ongoing monitoring of emerging legal issues and regulatory changes and employee education programs that include anti-money laundering and anti-terrorist financing, privacy and information security risk management as well as reporting breaches and Empire Life’s code of business conduct. The framework is supported by a network of business unit compliance officers as well as the corporate legal services department. The Chief Compliance Officer reports regularly to the Conduct Review Committee of the Board on the state of compliance, key compliance risks and emerging regulatory trends. The General Counsel reports regularly to the Audit Committee of the Board on litigation activity. (2) Model Risk Empire Life uses models to support many business functions including investment analysis, product development and pricing, valuation of policy liabilities, financial planning, asset/liability management, capital management, project management and risk management. The risk of inappropriate use or interpretation of Empire Life’s models or their output, or the use of deficient models, data or assumptions could result in financial losses or inappropriate business decisions. Empire Life has developed management and mitigation processes related to model use and oversight of models to limit financial, operational and strategic impacts from an error or misinterpretation of model results. Senior management has overall responsibility and accountability for models in use to support activities within their business area. The Chief Risk Officer reports regularly to the Risk and Capital Committee of the Board on model use and related oversight activities. (3) Human Resources Risk Competition for qualified employees, including executives, is intense both in the financial services industry and non- financial industries. If Empire Life is unable to retain and attract qualified employees and executives, the results of its operations and financial condition, including its competitive position, could be adversely affected. To mitigate this risk, Empire Life has a number of human resources policies, processes and practices in place. Management reports regularly to the Human Resources Committee of the Board on succession planning and employee development programs as well as compensation practices and programs, all of which are designed to attract, motivate and retain high-performing and high-potential employees. (4) Third-Party Risk Empire Life obtains many different types of services from a number of third-party service providers and has outsourced certain business functions or processes to third parties. Should these third parties fail to deliver services in compliance with contractual or other service arrangements, Empire Life’s business may be adversely impacted. To mitigate this risk, Empire Life has established contracting guidelines as well as a Company-wide outsourcing risk management policy that provides guidance when considering, entering into or managing existing outsourcing arrangements commensurate with the risks associated with the service provider and the nature of the arrangement. Annually, management reports to the Conduct Review Committee of the Board on outsourcing activities including details on those arrangements deemed to be most material to Empire Life. (5) Technology, Information Security and Business Continuity Risk Empire Life relies on technology in virtually all aspects of its business and operations including the creation and support of new products and services, and the nature of life insurance business necessitates a substantial investment in technology. Operational integrity, data integrity and security of information and systems infrastructure are all relied upon for normal business operations. Disruptions due to system failure, information security breaches, privacy breaches, cyber-attacks, human errors, natural disasters, criminal activity, fraud or the loss of certain software licensing agreements could have a material adverse impact on Empire Life. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 27 MANAGEMENT'S DISCUSSION AND ANALYSIS Empire Life has an enterprise-wide business continuity and disaster recovery program overseen by the Business Continuity Planning Team and senior management. The program includes policies, plans and procedures designed so that, to the extent practically possible, key business functions can continue and normal operations can resume effectively and efficiently should a major disruption occur. Each business unit is accountable for preparing and maintaining detailed business continuity plans and processes. Empire Life establishes and regularly tests business continuity and disaster recovery plans and maintains off-site system facilities and other related services and failover capability designed to minimize downtime and accelerate system recovery. Information security breaches, including various forms of cyber-attack, could occur and may result in inappropriate disclosure or use of personal or confidential information. To mitigate this risk, Empire Life has an information security program overseen by the VP Enterprise Services and Security, who reports at least annually to the Risk and Capital Committee of the Board. This program consists of a number of standards, procedures and guidelines focused on management of cybersecurity risk and maintenance of the security and integrity of the data entrusted to Empire Life. An incident management process is in place for monitoring and managing security events. Privacy breaches could occur and may result in unauthorized disclosure or use of private and confidential information. To manage this risk, Empire Life has a privacy program overseen by the Chief Privacy Officer. The program includes policies and standards, ongoing monitoring of emerging privacy legislation and a network of business unit privacy officers. Processes have been established to provide guidance to employees on the handling of personal information and the reporting of privacy incidents and issues to appropriate management for response and resolution. The Chief Privacy Officer reports regularly to the Conduct Review Committee of the Board on privacy and data security risks and emerging trends. Business and Strategic Risk Business and strategic risk relates to the uncertainty in future earnings and capital related to the potential inability to implement appropriate business plans and strategies, make decisions, allocate resources, manage distribution or adapt to changes in business environment, such as the competitive landscape, regulatory and tax changes or changes in accounting and actuarial standards. Empire Life regularly reviews and adapts its business strategies and plans in consideration of changes in the external business environment, economic, political and regulatory environment. Empire Life’s financial performance is dependent upon its ability to implement and execute business strategies and plans for growth. Empire Life’s business strategies and plans are designed to align with risk appetite, capital position and financial performance objectives. Empire Life periodically reassesses risk appetite taking into consideration the economic, regulatory and competitive environments in which it operates. The current environment requires Empire Life to adapt rapidly to new opportunities and challenges and to refine its strategies accordingly. If Empire Life fails to revise its strategies on a timely basis or adapt to the changing environment, it may not be able to achieve its growth objectives. Empire Life’s business strategies and plans are dependent on the successful execution of organizational and strategic initiatives designed to support the growth of its business. The ability to effectively manage these changes and prioritize initiatives directly affects Empire Life’s ability to execute these strategies. Identifying and implementing the right set of initiatives is critical to achieving Empire Life’s business plan targets. Failure to implement these initiatives could also lead to cost structure challenges. Successful execution of Empire Life’s business strategies and plans depends on a number of factors including its ability to (i) generate sufficient earnings to maintain an adequate level of capital; (ii) generate sustained investment performance; (iii) meet regulatory requirements; (iv) manage risk exposures effectively; (v) attract and retain customers and distributors;(vi) have the right set of products; and (vii) reduce operating expenses while maintaining the ability to hire, retain and motivate key personnel. Empire Life’s business and strategic plans are reviewed and discussed by its senior management team and are subject to approval by the Board of Directors, which also receives regular updates on implementation progress against key business plan objectives. The Board and its subcommittees receive regular updates on key risks. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 28 MANAGEMENT'S DISCUSSION AND ANALYSIS In addition to the discussion of risks included in this MD&A, a comprehensive discussion of the material risks that impact Empire Life is included in Empire Life’s Annual Information Form available at www.sedar.com. Additional disclosures of Empire Life’s sensitivity to risks are included in note 27 to the 2019 consolidated financial statements. Disclosure Controls and Procedures Empire Life’s disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by Empire Life under Canadian securities laws is recorded, processed, summarized and reported within the specified time periods, and include controls and procedures that are designed to ensure that information is accumulated and communicated to management on a timely basis to allow appropriate decisions regarding public disclosure. Under the supervision of management, an evaluation was carried out on the effectiveness of Empire Life’s disclosure controls and procedures as of December 31, 2019. Based on that evaluation, management concluded that Empire Life’s disclosure controls and procedures were effective as at December 31, 2019. Internal Control over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with IFRS. Under the supervision of management, an evaluation of Empire Life’s internal control over financial reporting was carried out as at December 31, 2019. Based on that evaluation, management concluded that Empire Life’s internal control over financial reporting was effective as at December 31, 2019. No changes were made in Empire Life’s internal control over financial reporting during the year ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, Empire Life’s internal control over financial reporting. Critical Accounting Estimates Empire Life’s significant accounting policies are described in note 2 to the consolidated financial statements. Certain of these policies require management to make estimates and assumptions about matters that are inherently uncertain. The most critical of these accounting estimates for Empire Life are the valuation of policy liabilities, financial instrument classification, pension and other employee future benefits and the determination of allowances for impaired investments. Policy Liabilities The determination of policy liabilities requires best estimate assumptions that cover the remaining life of the policies for mortality, morbidity, investment returns, persistency, expenses, inflation and taxes and include consideration of related reinsurance effects. Due to the long-term risks and measurement uncertainties inherent in the life insurance business, a margin for adverse deviation from best estimates is included in each assumption. These margins allow for possible deterioration in future experience and provide for greater confidence that policy liabilities are adequate to pay future benefits. The resulting provisions for adverse deviations have the effect of increasing policy liabilities and decreasing the income that otherwise would have been recognized at policy inception. A range of allowable margins is prescribed by the Canadian Institute of Actuaries. Assumptions are reviewed and updated at least annually and the impact of changes in those assumptions is reflected in earnings in the year of the change. Empire Life’s sensitivities to risks related to policy liabilities are included in note 27 to the consolidated financial statements. Financial Instrument Classification Management judgment is used to classify financial instruments as fair value through profit or loss, available for sale or loans and receivables. Most financial assets supporting insurance contract liabilities and investment contract liabilities are designated as FVTPL. Most financial assets supporting capital and surplus and participating accounts are classified as AFS. Loans and receivables support both contract liabilities and capital and surplus. The designation of a financial instrument as FVTPL or AFS dictates whether unrealized fair value changes are reported in net income or other comprehensive income. Additional information regarding financial instrument classification is included in notes 2(d), 3(a), 3(b), and 10(c). Pension and Other Employee Future Benefits Pension and other employee future benefits expense is calculated by independent actuaries using assumptions determined by management. The assumptions made affect the pension and other employee future benefits expense included in net income. If actual experience differs from the assumptions used, the resulting experience gain or loss is 1 See Non-IFRS Measures Empire Life - Annual Report 2019 29 MANAGEMENT'S DISCUSSION AND ANALYSIS recorded in OCI. Additional information regarding pension and other employee future benefits is included in notes 2(k), and 12. Provision for Impaired Investments Empire Life maintains a prudent policy in setting the provision for impaired investments. When there is no longer reasonable assurance of full collection of loan principal and loan interest related to a mortgage or policy contract loan, management establishes a specific provision for loan impairment and charges the corresponding reduction in carrying value to income in the period the impairment is identified. In determining the estimated realizable value of the investment, management considers a number of events and conditions. These include the value of the security underlying the loan, geographic location, industry classification of the borrower, an assessment of the financial stability of the borrower, repayment history and an assessment of the impact of current economic conditions. Changes in these circumstances may cause subsequent changes in the estimated realizable amount of the investment and changes in the specific provision for impairment. Available for sale securities are subject to a regular review for losses that are significant or prolonged. Objective evidence of impairment exists if there has been a significant or prolonged decline in the fair value of the investment below its cost or if there is a significant adverse change in the technological, market, economic or legal environment in which the issuer operates or the issuer is experiencing financial difficulties. Outlook The Canadian economy performed largely as expected in 2019 with GDP growth estimated at 1.6% for the full year, the Canadian dollar weakened slightly to 1.32 (annual average) per U.S. dollar and annual unemployment was stable at 5.6%, the lowest it has been since the 1970’s. Consumer spending has slowed down gradually throughout the year and business investment in machinery and equipment has slowed significantly after a strong first quarter in 2018. A number of uncertainties will continue in 2020 which may negatively impact the Canadian economy including slower global demand, on-going trade tensions, geopolitical concerns (e.g. North Korea, Iran, Brexit, Italy), and central bank monetary policy. The Bank of Canada left the overnight rate unchanged in 2019, sitting at 1.75%. The Canadian Federal Bond yield curve shifted down with the 5-year rate decreasing from 1.88% to 1.68% in 2019 and the 30-year rate decreasing from 2.18% to 1.76% in 2019. Corporate and provincial bond spreads tightened during 2019. Interest rates have generally been lower than typical levels for several years. Global equity markets performed well in 2019 with the MSCI up over 27% for the year. The S&P 500 stock index was up 28.9% and the S&P/TSX composite index was up 19.1% for the year. Stock market conditions impact the in-force profit margins and new business growth for the segregated fund and mutual fund portions of Empire Life’s Wealth Management product line. Looking forward to 2020, the global economy is expected to have moderate growth. The Canadian economy is expected to continue to grow at a slower pace than in 2019 with forecast GDP of 1.6% slightly below the estimated 2% in 2019. The western provinces are expected to continue to grow, with British Columbia benefiting from the natural gas projects. Provinces in central Canada are expected to experience slower growth with oil production cuts and pull back on capital spending plans. The Atlantic Provinces are expected to grow at a more moderate pace. Short-term interest rates are expected to continue to rise in the U.S. as well as in Canada but at a much slower pace and likely in the second half of the year. Overall the Canadian economy is well positioned to support continued growth of all Empire Life’s product lines. The individual insurance market continues to grow modestly even with the challenge of the persistent low long-term interest rate environment that followed the financial crisis. Empire Life has decreased its emphasis on long-term life insurance products in favor of shorter term products, such as 10 year renewable term life insurance. Long-term interest rates, product mix and product pricing are expected to continue to be challenges for Empire Life’s Individual Insurance product line. The segregated fund product line saw a decline in net sales while experience positive market returns in 2019; fees will likely be impacted by competition going forward. Empire Life will continue to develop low cost efficient products delivered digitally to satisfy consumer needs. Within the employee benefits product line, although highly concentrated Empire Life will continue to penetrate its niche market to grow the business. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 30 MANAGEMENT'S DISCUSSION AND ANALYSIS As noted under the Regulatory Capital section, OSFI implemented its Life Insurance Capital Adequacy Test (LICAT) Guidelines on January 1, 2018. This new Guideline established a new risk based regulatory capital framework for life insurance companies and replaced the previous MCCSR Guideline. LICAT is intended to improve the quality of capital available and provide a better alignment of risk measures with the long-term economics of the insurance business. This new Guideline was developed in consultation with the Life Insurance Industry and OSFI. OSFI is also reviewing the overall approach for determining capital requirements for segregated fund guarantee risks. Changes to the capital required for products with guaranteed income may ultimately impact the industry’s ability to offer these products at reasonable prices to the consumer. OSFI has indicated that the effective date for the Guideline for segregated fund guarantee will be implemented at the same time as IFRS 17. OSFI is continuing to review the application of Non- Viable Contingent Capital (NVCC) for life insurance companies. If NVCC applied, new preferred shares and subordinated debentures issued after the transition date would have to be compliant with the new regime to qualify as capital. The International Accounting Standards Board (IASB) issued IFRS 17, Accounting Standards for Insurance Contracts, in May 2017. IFRS 17 will include fundamental changes from the CALM method (equivalent to IFRS 4 Insurance Contracts) that Empire Life currently applies for the valuation of insurance contracts and revenue recognition. The IASB has also granted a temporary exemption from the application of IFRS 9 Financial Instruments to allow insurance companies the ability to implement both IFRS 17 and IFRS 9 concurrently. IFRS 9 applies to the measurement of financial assets, the expected credit loss model and hedge accounting. For insurance contracts and financial instruments accounting, the goal is global consistency under IFRS as opposed to the differing approaches in each country that exist today. Preparing for the adoption of IFRS 17 and IFRS 9 is a significant initiative for Empire Life and for the industry. Empire Life is currently assessing the impact that IFRS 17 and IFRS 9 will have on Empire Life’s consolidated financial statements as well as developing a plan to implement the changes required to be ready to report under the new standards when they take effect. The Canadian Securities Administrators (CSA) has increased disclosure requirements for mutual fund companies, including point of sale requirements and customer relationship model initiatives. Mutual fund fees continue to be an area of interest for Canadian securities regulators. The CSA commissioned independent third-party research that will assess the impact of commissions and embedded (trailer) fees on mutual fund flows. This research will support CSA policy decisions concerning Canada's current mutual fund fee structure. Empire Life continues to monitor these developments and assess the possible impact to the insurance industry at some future date. The industry is also improving the oversight of Managing General Agents (MGAs) and their advisors. Life insurance companies, including Empire Life, commonly contract with MGAs as a key component of the distribution chain for insurance and wealth management products. In 2013, the Canadian Life and Health Insurance Association (CLHIA) developed a new Insurer-MGA Relationship guideline (effective January 1, 2015). The Guideline describes desired outcomes and related practices in five general areas, including, perform due diligence prior to entering into a contract with an MGA, clearly set out roles and responsibilities in the contract, commit to a culture of treating customers fairly, monitor the performance of the MGA and retain ultimate responsibility. The industry is also considering establishing a licensing regime for all distribution firms. The licensing of distribution firms would clarify the accountability for the distribution partners to adhere to the insurer’s code of conduct and provide on-going monitoring of the advisors activities. Quarterly Results The following table summarizes various financial results on a quarterly basis for the most recent eight quarters: (in millions of dollars, except per share amounts) 2019 2019 2019 2019 2018 2018 2018 2018 Dec 31 Sep 30 Jun 30 Mar 31 Dec 31 Sep 30 Jun 30 Mar 31 Revenue Common shareholder's net income $ $ 249 $ 475 $ 603 $ 788 $ 289 $ 197 $ 388 $ 76 $ 35 $ 20 $ 43 $ 6 $ 35 $ 57 $ 264 39 Earnings per share - basic and diluted $ 77.25 $ 35.29 $ 20.45 $ 43.59 $ 6.36 $ 35.73 $ 58.14 $ 39.30 Forward-Looking Statements and Information 1 See Non-IFRS Measures Empire Life - Annual Report 2019 31 MANAGEMENT'S DISCUSSION AND ANALYSIS Certain statements in this MD&A about Empire Life’s current and future plans, expectations and intentions, results, market share growth and profitability, strategic objectives or any other future events or developments constitute forward-looking statements and information within the meaning of applicable securities laws. The words “may”, “will”, “would”, “should”, “could”, “expects”, “plans”, “intends”, “trends”, “indications”, “anticipates”, “believes”, “estimates”, “predicts”, “likely” or “potential” or the negative or other variations of these words or other comparable words or phrases, are intended to identify forward-looking statements and information. Although management believes that the expectations and assumptions on which such forward-looking statements and information are based are reasonable, undue reliance should not be placed on the forward-looking statements and information because there can be no assurance that they will prove to be correct. By their nature, such forward-looking statements and information are subject to various risks and uncertainties, which could cause the actual results and expectations to differ materially from the anticipated results or expectations expressed. These risks and uncertainties include, but are not limited to, market risk including equity risk, hedging risk, interest rate risk, foreign exchange rate risk; liquidity risk; credit risk including counterparty risk; insurance risk including mortality risk, policyholder behaviour risk, expense risk, morbidity risk, product design and pricing risk, underwriting and claims risk, reinsurance risk; operational risk, including legal and regulatory compliance risk, model risk, human resources risk, third-party risk, technology, information security and business continuity risk; and business risk and strategic, including risk with respect to competition, risk with respect to financial strength, capital adequacy risk, risk with respect to distribution channels, risk with respect to changes to applicable income tax legislation, risk with respect to litigation, risk with respect to reputation, risk with respect to risk management policies, risk with respect to intellectual property, risk with respect to significant ownership of common shares. Please see the section titled “Risk Factors” in Empire Life’s Annual Information Form available at www.sedar.com for more details on these risks. Material factors or assumptions that were applied in drawing a conclusion or making an estimate set out in the forward-looking statements and information include that the general economy remains stable; assumptions on interest rates, mortality rates and policy liabilities; and capital markets continue to provide access to capital. These factors are not intended to represent a complete list of the factors that could affect Empire Life; however, these factors should be considered carefully, and readers should not place undue reliance on forward-looking statements made herein or in the documents reproduced herein. To the extent any forward-looking information in this MD&A constitutes future-oriented financial information or financial outlooks within the meaning of securities laws, such information is being provided to demonstrate potential benefits and readers are cautioned that this information may not be appropriate for any other purpose. Future-oriented financial information and financial outlooks are, without limitation, based on the assumptions and subject to the risks set out above. The forward-looking information contained herein is expressly qualified in its entirety by this cautionary statement. When relying on Empire Life’s forward-looking statements and information to make decisions, investors and others should carefully consider the foregoing factors, assumptions and other uncertainties and potential events. Readers are cautioned not to place undue reliance on this forward-looking information, which is given as of the date hereof or the date indicated, and to not use such forward-looking information for anything other than its intended purpose. Empire Life undertakes no obligation to update publicly or revise any forward-looking statements and information, whether as a result of new information, future events or otherwise after the date of this document, except as required by law. Non-IFRS Measures Empire Life uses non-IFRS measures including return on common shareholders’ equity, source of earnings, assets under management, annualized premium sales, gross and net sales for mutual funds, segregated funds and fixed annuities to provide investors with supplemental measures of its operating performance and to highlight trends in its core business that may not otherwise be apparent when relying solely on IFRS financial measures. Empire Life also believes that securities analysts, investors and other interested parties frequently use non-IFRS measures in the evaluation of issuers. Empire Life’s management also uses non-IFRS measures in order to facilitate operating performance comparisons from period to period, to prepare annual operating budgets and to determine components of management compensation. Empire Life believes that these measures provide information useful to its shareholders and policyholders in evaluating Empire Life’s underlying financial results. 1 See Non-IFRS Measures Empire Life - Annual Report 2019 32 MANAGEMENT'S DISCUSSION AND ANALYSIS Return on common shareholders’ equity is a profitability measure that presents the net income available to common shareholders as a percentage of the average capital deployed to earn the income. Sources of earnings breaks down Empire Life’s earnings into several categories which are useful to assess the performance of the business. These categories include expected profit from in-force business, impact of new business, experience gains and losses, management actions and changes in assumptions, and earnings on surplus. The sources of earnings components are reconciled to net income. See the Overview section earlier in this report. Annualized premium sales is used as a method of measuring sales volume. It is equal to the premium expected to be received in the first twelve months for all new individual insurance and employee benefit policies sold during the period. Mutual fund gross and net sales and segregated fund gross and net sales are also used as measures of sales volume. Assets under management is a non-IFRS measure of the assets managed by Empire Life, which includes general fund assets, mutual fund assets and segregated fund assets. It represents the total assets of Empire Life and the assets its customers invest in. The following table provides a reconciliation of assets under management to total assets in Empire Life’s financial statements. Reconciliation of Assets Under Management As at (in millions of dollars) Assets Under Management General fund assets Segregated fund assets Total assets per financial statements Mutual fund assets Assets under management December 31, 2019 December 31, 2018 $ $ 9,462 $ 8,499 17,961 139 18,100 $ 8,447 7,823 16,270 145 16,415 The above table includes the following amounts held by Empire Life’s defined benefit (DB) pension plans. As at (in millions of dollars) DB plan assets Segregated fund assets Mutual fund assets December 31, 2019 December 31, 2018 $ 203 $ 14 182 12 1 See Non-IFRS Measures Empire Life - Annual Report 2019 33 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING The consolidated financial statements in this annual report have been prepared by management, who is responsible for their integrity, objectivity and reliability. This responsibility includes selecting and applying appropriate accounting policies, making judgements and estimates, and ensuring information contained throughout the annual report is consistent with these statements. The consolidated financial statements are prepared in accordance with International Financial Reporting Standards (IFRS) and the accounting requirements of the Office of the Superintendent of Financial Institutions, Canada (OSFI). The Company maintains a system of internal control over financial reporting which is designed to provide reasonable assurance that assets are safeguarded, expenditures are made in accordance with authorizations of management and directors, transactions are properly recorded, and the financial records are reliable for preparing the consolidated financial statements in accordance with (IFRS). Under the supervision of management, an evaluation of the effectiveness of the Company’s internal control over financial reporting was carried out as at December 31, 2019. Based on that evaluation, management concluded that the Company’s internal control over financial reporting was effective as at December 31, 2019. The Board of Directors, acting through the Audit Committee which is comprised of directors who are not officers or employees of the Company, oversees management’s responsibility for financial reporting and for internal control systems. The Audit Committee is responsible for reviewing the consolidated financial statements and annual report and recommending them to the Board of Directors for approval. The Audit Committee meets with management, internal audit and the external auditors to discuss audit plans, internal controls over accounting and financial reporting processes, auditing matters, and financial reporting issues. The Appointed Actuary is appointed by the Board of Directors and is responsible for ensuring that the assumptions and methods used in the valuation of the policy liabilities are in accordance with accepted actuarial practice and regulatory requirements. The Appointed Actuary is required to provide an opinion regarding the appropriateness of the policy liabilities at the consolidated statement of financial position date to meet all policyholder obligations of the Company. Examination of supporting data for accuracy and completeness and analysis of Company assets for their ability to support the amount of policy liabilities are important elements of the work required to form this opinion. The Appointed Actuary is also required each year to analyze the financial condition of the Company and prepare a report for the Board of Directors. The analysis tests the capital adequacy of the Company under adverse economic and business conditions for the current year and the next four years. PricewaterhouseCoopers’ responsibility as external auditors is to report to the policyholders, shareholders and OSFI regarding the fairness of presentation of the Company’s annual consolidated financial statements. The external auditors have full and free access to, and meet periodically with, the Audit Committee to discuss their audit. The Independent Auditor’s Report outlines the scope of their examination and their opinion. Mark Sylvia President and Chief Executive Officer Kingston, Ontario February 26, 2020 Edward Gibson Senior Vice-President, Chief Financial Officer and Chief Actuary Kingston, Ontario February 26, 2020 Empire Life - Annual Report 2019 34 INDEPENDENT AUDITOR'S REPORT To the Policyholders and Shareholders of The Empire Life Insurance Company Our opinion In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of The Empire Life Insurance Company and its subsidiaries (together, the Company) as at December 31, 2019 and 2018, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IFRS). What we have audited The Company's consolidated financial statements comprise: • • • • • • the consolidated statements of financial position as at December 31, 2019 and 2018; the consolidated statements of operations for the years then ended; the consolidated statements of comprehensive income for the years then ended; the consolidated statements of changes in equity for the years then ended; the consolidated statements of cash flows for the years then ended; and the notes to the consolidated financial statements, which include a summary of significant accounting policies. Basis for opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Independence We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada. We have fulfilled our other ethical responsibilities in accordance with these requirements. Other information Management is responsible for the other information. The other information comprises the Management's Discussion and Analysis and the information, other than the consolidated financial statements and our auditor's report thereon, included in the annual report. Our opinion on the consolidated financial statements does not cover the other information and we will not express any form of assurance conclusion thereon. In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard. Empire Life - Annual Report 2019 35 INDEPENDENT AUDITOR'S REPORT Responsibilities of management and those charged with governance for the consolidated financial statements Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRS, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. In preparing the consolidated financial statements, management is responsible for assessing the Company's ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Company’s financial reporting process. Auditor’s responsibilities for the audit of the consolidated financial statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: • • • • • • Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Company to cease to continue as a going concern. Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation. Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Company to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. Empire Life - Annual Report 2019 36 INDEPENDENT AUDITOR'S REPORT We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. The engagement partner on the audit resulting in this independent auditor’s report is Owen Thomas. PricewaterhouseCoopers LLP Chartered Professional Accountants, Licensed Public Accountants Toronto, Ontario February 26, 2020 Empire Life - Annual Report 2019 37 APPOINTED ACTUARY'S REPORT To the Policyholders and Shareholders of The Empire Life Insurance Company I have valued the policy liabilities and reinsurance liabilities of The Empire Life Insurance Company for its Consolidated statements of financial position at December 31, 2019 and their change in the Consolidated statements of operations for the year then ended in accordance with accepted actuarial practice in Canada including selection of appropriate assumptions and methods. In my opinion, the amount of policy liabilities net of reinsurance liabilities, makes appropriate provision for all policy obligations and the Consolidated financial statements fairly present the results of the valuation. Dan Doyle, FSA, FCIA, MAAA Fellow, Canadian Institute of Actuaries Kingston, Ontario February 26, 2020 Empire Life - Annual Report 2019 38 CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (in thousands of Canadian dollars) As at December 31 Assets Cash and cash equivalents (Note 3) Investments Short-term investments (Note 3) Bonds (Note 3) Preferred shares (Note 3) Common shares (Note 3) Derivative assets (Note 3) Mortgages (Note 3) Loans on policies (Note 3) Policy contract loans (Note 3) 2019 2018 $ 140,333 $ 204,921 32,384 7,509,652 474,029 842,029 2,930 169,827 55,363 66,520 27,959 6,530,080 395,860 795,123 10,424 193,074 51,949 69,180 Total cash and cash equivalents and investments 9,293,067 8,278,570 Accrued investment income Insurance receivables (Note 4) Current income taxes Other assets (Note 5) Property and equipment (Note 6) Intangible assets (Note 7) Investment in associate Segregated fund assets (Note 8) Total assets Liabilities Accounts payable and other liabilities (Note 11) Insurance payables (Note 9) Current income taxes payable Reinsurance liabilities (Note 10) Insurance contract liabilities (Note 10) Investment contract liabilities Policyholders' funds on deposit Provision for profits to policyholders Deferred income taxes (Note 18) Subordinated debt (Note 13) Segregated fund policy liabilities Total liabilities Equity Preferred shares (Note 20) Common shares (Note 20) Contributed surplus Retained earnings Accumulated other comprehensive income Total equity Total liabilities and equity $ $ 35,401 48,728 — 23,096 22,016 22,357 17,541 35,388 46,701 23,666 20,202 24,576 17,804 — 8,498,583 17,960,789 $ 7,822,790 16,269,697 106,037 $ 95,578 44,592 698,372 6,073,868 28,866 34,224 32,924 8,805 399,098 8,498,583 16,020,947 249,500 985 19,387 1,636,152 33,818 1,939,842 105,171 93,548 — 788,801 5,176,423 25,154 34,031 32,008 10,288 398,767 7,822,790 14,486,981 249,500 985 19,387 1,527,712 (14,868) 1,782,716 $ 17,960,789 $ 16,269,697 Duncan N. R. Jackman Chairman of the Board Mark Sylvia President and Chief Executive Officer The accompanying notes are an integral part of these consolidated financial statements. Empire Life - Annual Report 2019 39 CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands of Canadian dollars except per share amounts and shares authorized and outstanding) For the year ended December 31 Revenue Gross premiums (Note 14) Premiums ceded to reinsurers (Note 14) Net premiums (Note 14) Investment income (Note 3) Fair value change in fair value through profit or loss assets Realized gain (loss) on fair value through profit or loss assets sold Realized gain (loss) on available for sale assets including impairment write downs (Note 3) Fee income (Note 15) Total revenue Benefits and expenses Gross benefits and claims paid (Note 16) Claims recovery from reinsurers (Note 16) Gross change in insurance contract liabilities (Note 16) Change in insurance contract liabilities ceded (Note 16) Change in investment contracts provision Policy dividends Operating expenses (Note 17) Commissions Commission recovery from reinsurers Interest expense Total benefits and expenses Premium tax Investment and capital tax Net income before income taxes Income taxes (Note 18) Net income Less: net income (loss) attributable to participating policyholders Shareholders' net income (loss) Less: preferred share dividends declared (Note 21) Common shareholders' net income Earnings per share - basic and diluted (Note 19) (2,000,000 shares authorized; 985,076 shares outstanding) 2019 2018 $ 1,091,828 $ 1,020,640 (181,987) 909,841 325,717 490,381 105,331 21,886 261,745 2,114,901 720,316 (102,055) 897,445 (90,429) 937 31,438 172,470 214,263 (15,509) 14,425 1,843,301 18,675 3,770 249,155 58,497 $ $ $ 190,658 $ 3,219 187,439 13,496 173,943 $ 176.58 $ (147,035) 873,605 308,428 (318,039) 11,900 (1,411) 263,941 1,138,424 670,256 (100,496) (188,442) 138,000 85 30,124 164,656 202,395 (4,198) 18,132 930,512 19,037 3,922 184,953 37,064 147,889 (3,052) 150,941 13,496 137,445 139.53 The accompanying notes are an integral part of these consolidated financial statements. Empire Life - Annual Report 2019 40 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands of Canadian dollars) For the year ended December 31 Net income Other comprehensive income (loss), net of income taxes: Items that may be reclassified subsequently to net income: Unrealized fair value change on available for sale investments (Note 18) Fair value change on available for sale investments reclassified to net income, including impairment write downs (Note 18) Net unrealized fair value increase (decrease) Items that will not be reclassified to net income: Remeasurements of post-employment benefit liabilities (Note 18) Total other comprehensive income (loss) Comprehensive income (loss) Comprehensive income (loss) attributable to: Participating policyholders Shareholders Total 2019 2018 $ 190,658 $ 147,889 65,612 (16,002) 49,610 (924) 48,686 (28,312) 649 (27,663) (4,595) (32,258) $ $ $ 239,344 $ 115,631 3,949 $ 235,395 239,344 $ (7,058) 122,689 115,631 The accompanying notes are an integral part of these consolidated financial statements. Empire Life - Annual Report 2019 41 CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (in thousands of Canadian dollars) For the year ended December 31 2019 2018 Preferred shares (Note 20) $ 249,500 $ — $ 249,500 $ 249,500 $ — $ 249,500 Shareholders' Policyholders' Total Shareholders' Policyholders' Total Common shares (Note 20) Contributed surplus Retained earnings 985 19,387 — — 985 985 19,387 19,387 — — 985 19,387 Retained earnings - beginning of year 1,492,447 Net income (loss) Preferred share dividends declared Common share dividends declared 187,439 (13,496) (68,722) 35,265 3,219 — — 1,527,712 1,395,002 190,658 (13,496) (68,722) 150,941 (13,496) (40,000) 38,317 (3,052) — — 1,433,319 147,889 (13,496) (40,000) Retained earnings - end of period 1,597,668 38,484 1,636,152 1,492,447 35,265 1,527,712 Accumulated other comprehensive income (loss) Accumulated other comprehensive income (loss) - beginning of year Other comprehensive income (loss) Accumulated other comprehensive income (loss) - end of period (15,766) 47,956 898 730 (14,868) 48,686 12,486 (28,252) 4,904 (4,006) 17,390 (32,258) 32,190 1,628 33,818 (15,766) 898 (14,868) Total equity $ 1,899,730 $ 40,112 $ 1,939,842 $ 1,746,553 $ 36,163 $ 1,782,716 Composition of accumulated other comprehensive income (loss) - end of period Unrealized gain (loss) on available for sale financial assets Remeasurements of post-employment benefit liabilities Shareholder portion of policyholders' accumulated other comprehensive income Total accumulated other comprehensive income (loss) $ 46,212 $ 2,513 $ 48,725 $ (2,605) $ 1,720 $ (885) (14,167) (740) (14,907) (13,283) (700) (13,983) 145 (145) — 122 (122) — $ 32,190 $ 1,628 $ 33,818 $ (15,766) $ 898 $ (14,868) The accompanying notes are an integral part of these consolidated financial statements. Empire Life - Annual Report 2019 42 CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of Canadian dollars) For the year ended December 31 Operating activities Net income Non-cash items affecting net income: Change in contract liabilities Change in reinsurance liabilities Fair value change in fair value through profit or loss assets Realized (gain) loss on assets including impairment write downs on available for sale assets Amortization related to discount on debt instruments Amortization related to property and equipment and intangible assets (Notes 6 & 7) Deferred income taxes (Note 18) Other items Cash provided from (used for) operating activities Investing activities Portfolio investments Purchases and advances Sales and maturities Loans on policies Advances Repayments (Increase) decrease in short-term investments Purchases of property and equipment and intangible assets (Notes 6 & 7) Investment in associate Cash provided from (used for) investing activities Financing activities Dividends paid to common shareholders (Note 21) Dividends paid to preferred shareholders (Note 21) Interest paid on subordinated debt Redemption of subordinated debt (Note 13) Cash provided from (used for) financing activities Net change in cash and cash equivalents Cash and cash equivalents - beginning of year (Note 3) Cash and cash equivalents - end of year (Note 3) Supplementary cash flow information related to operating activities: Income taxes paid, net of (refunds) Interest income received Dividend income received 2019 2018 $ 190,658 $ 147,889 898,382 (90,429) (490,381) (127,217) (88,161) 9,975 (1,147) 66,729 368,409 (188,357) 138,000 318,039 (10,489) (85,178) 9,461 (1,806) 18,810 346,369 (2,298,947) 1,996,910 (1,679,078) 1,512,761 (10,738) 10,024 (4,425) (11,968) (17,541) (336,685) (68,722) (13,496) (14,094) — (96,312) (64,588) 204,921 140,333 $ 28,729 $ 190,431 51,072 (10,093) 15,327 99,783 (6,986) — (68,286) (40,000) (13,306) (14,094) (300,000) (367,400) (89,317) 294,238 204,921 54,590 189,652 46,901 $ $ The accompanying notes are an integral part of these consolidated financial statements. Empire Life - Annual Report 2019 43 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 1. Description of Company and Summary of Operations The Empire Life Insurance Company (the Company or Empire Life) was founded in 1923 when it was organized under a provincial charter in Toronto. Authorization to continue as a federal corporation was obtained in 1987. The Company underwrites life and health insurance policies and provides segregated funds, mutual funds and annuity products for individuals and groups across Canada. The Company is a subsidiary of E-L Financial Corporation Limited (the Parent or E-L). The head office, principal address and registered office of the Company are located at 259 King Street East, Kingston, Ontario, K7L 3A8. Empire Life is a Federally Regulated Financial Institution, regulated by the Office of the Superintendent of Financial Institutions, Canada (OSFI). Empire Life became a public company on August 5, 2015 and registered as a public issuer with the Ontario Securities Commission. The Company established a mutual fund subsidiary in 2011, Empire Life Investments Inc. (ELII). ELII became a registered Investment Funds Manager on January 5, 2012. The head office for ELII is located at 165 University Avenue, 9th Floor, Toronto, Ontario, M5H 3B8. These Consolidated Financial Statements were approved by the Company’s Board of Directors (the Board) on February 26, 2020. 2. Significant Accounting Policies (a) Basis of preparation The annual Consolidated Financial Statements of the Company for the year ended December 31, 2019 have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). These Consolidated Financial Statements have been prepared on a fair value measurement basis, with the exception of certain assets and liabilities. Insurance contract liabilities and Reinsurance assets/ liabilities are measured on a discounted basis in accordance with accepted actuarial practice. Investment contract liabilities, Mortgages, Policy contract loans and Loans on policies are carried at amortized cost. Certain other assets and liabilities are measured on a historical cost basis, as explained throughout this note. All amounts included in the Consolidated Financial Statements are presented in thousands of Canadian dollars except for per share amounts and where otherwise stated. These Consolidated Financial Statements also comply with the accounting requirements of OSFI, none of which are an exception to IFRS. (b) Basis of consolidation The Company’s Consolidated Financial Statements include the assets, liabilities, results of operations and cash flows of the Company and its wholly-owned and controlled subsidiary, ELII. The Company owns 100% of the voting shares and maintains control of its subsidiary. The Company controls an entity when the Company is exposed to, or has rights to, variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. Subsidiaries are fully consolidated from the date on which control is transferred to the Company. They are deconsolidated from the date that control ceases. The financial statements of ELII are prepared for the same reporting period as the Company, using consistent accounting policies. All significant inter-company transactions, balances, income and expenses are eliminated in full on consolidation. (c) Critical accounting estimates and judgements The preparation of the Consolidated Financial Statements, in accordance with IFRS, requires management to make judgements and estimates and form assumptions that affect the reported amounts of assets and liabilities as at the date of the Consolidated Financial Statements, and the reported amounts of revenue and expenses during the year. On an ongoing basis, management evaluates its judgements, estimates and critical assumptions in relation to assets, liabilities, revenues and expenses. Actual results could differ from these estimates and changes in estimates are recorded in the accounting period in which they are determined. Empire Life - Annual Report 2019 44 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The Company considers the following items to be particularly susceptible to changes in estimates and judgements: (i) Insurance-related liabilities Liabilities for insurance contracts are determined using the Canadian Asset Liability Method (CALM), which incorporates best-estimate assumptions for mortality, morbidity, policy lapses, surrenders, future investment yields, policy dividends, administration costs and margins for adverse deviation. These assumptions are reviewed at least annually and are updated to reflect actual experience and market conditions. Changes in the assumptions and margins for adverse deviation can have a significant impact on the valuation of insurance related liabilities. Additional information regarding insurance-related liabilities is included in Notes 2(e), 2(l),10 and 27. (ii) Financial instruments classification Management judgement is used to classify financial instruments as fair value through profit or loss (FVTPL), available for sale (AFS) or loans and receivables. Most financial assets supporting insurance contract liabilities and investment contract liabilities are designated as FVTPL. Most financial assets supporting capital and surplus and participating accounts are classified as AFS. Loans and receivables support both contract liabilities and capital and surplus. The designation of a financial instrument as FVTPL or AFS dictates whether unrealized fair value changes are reported in Net income or Other comprehensive income (OCI). Additional information regarding financial instrument classification is included in Notes 2(d), 3(a), 3(b) and 10(c). (iii) Pension and other post-employment benefits Pension and other employee future benefits expense is calculated by independent actuaries using assumptions determined by management. The assumptions made affect the pension and other employee future benefits expense included in Net income. If actual experience differs from the assumptions used, the resulting experience gain or loss is recorded in OCI. Additional information regarding pension and other post-employment benefits is included in Notes 2(k) and 12. (iv) Impairment AFS securities and loans and receivables are reviewed at each quarter-end reporting period to identify and evaluate investments that show indications of possible impairment. For AFS securities and loans and receivables, impairment losses are recognized if there is objective evidence of impairment as a result of an event that reduces the estimated future cash flows of the instrument and the impact can be reliably estimated. Objective evidence of impairment includes, but is not limited to, bankruptcy or default, delinquency by a debtor, and specific adverse conditions affecting an industry or a region. In addition, for equity securities, a significant or prolonged decline in the fair value of a security below its cost is objective evidence of impairment. The decision to record a write-down, its amount and the period in which it is recorded could change if management’s assessment of those factors were different. Impairment write-downs on debt securities are not recorded when impairment is due to changes in market interest rates, if future contractual cash flows associated with the debt security are still expected to be recovered. Additional information regarding impairment is included in Notes 2(d), 3(b), 10(c) and 27(c). Empire Life - Annual Report 2019 45 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (d) Financial instruments (i) Fair value Fair value is the amount of consideration that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act. When a financial instrument is initially recognized, its fair value is generally the value of the consideration paid or received. Subsequent to initial recognition, the fair value of a financial asset or liability quoted in an active market is generally the closing price. For financial instruments such as cash equivalents and short-term investments that have a short duration, the carrying value of these instruments approximates fair value. Fair value measurements used in these Consolidated Financial Statements have been classified by using a fair value hierarchy based upon the transparency of the inputs used in making the measurements. The three levels of the hierarchy are: Level 1 - Fair value is based on unadjusted quoted prices for identical assets or liabilities in an active market. The types of financial instruments classified as Level 1 generally include cash and exchange traded common and preferred shares and derivatives. Level 2 - Fair value is based on quoted prices for similar assets or liabilities in active markets, valuation that is based on significant observable inputs, or inputs that are derived principally from or corroborated with observable market data through correlation or other means. The types of financial instruments classified as Level 2 generally include cash equivalents, government bonds, certain corporate and private bonds, short-term investments, certain common shares (real estate limited partnership units) and over the counter derivatives. Level 3 - Fair value is based on valuation techniques that require one or more significant inputs that are not based on observable market inputs. These unobservable inputs reflect the Company’s expectations about the assumptions market participants would use in pricing the asset or liability. All of the Company’s financial instruments requiring fair value measurement meet the requirements of Level 1 or Level 2 of the fair value hierarchy. (ii) Cash and cash equivalents and investments Cash and cash equivalents are short-term, highly liquid investments that are subject to insignificant changes in value and are readily convertible into known amounts of cash. Cash equivalents comprise financial assets with maturities of three months or less from the date of acquisition. Short-term investments comprise financial assets with maturities of greater than three months and less than one year when acquired. Most financial assets supporting insurance contract liabilities and investment contract liabilities are designated as FVTPL. These assets may be comprised of cash and cash equivalents, short-term investments, bonds and debentures, common and preferred shares, futures, forwards and options. Changes in the fair value of these financial assets are recorded in Fair value change in FVTPL assets in the Consolidated Statements of Operations in the period in which they occur. Most financial assets supporting capital and surplus and participating accounts are classified as AFS. These assets may be comprised of short-term investments, bonds and debentures or common and preferred shares. AFS assets are carried at fair value in the Consolidated Statements of Financial Position. Except for foreign currency gains and losses on monetary AFS assets and impairment losses, any changes in the fair value are recorded, net of income taxes, in OCI. Gains and losses realized on sale or maturity of AFS assets are reclassified from OCI to Realized gain (loss) on AFS assets in the Consolidated Statements of Operations. Empire Life - Annual Report 2019 46 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Loans and receivables may include mortgage loans, loans on policies and policy contract loans. These assets are recorded at amortized cost, using the effective interest rate method, net of provisions for impairment losses, if any. Mortgage loans are secured by real estate. Loans on policies and policy contract loans are secured by policy values. Loans and receivables are defined as non- derivative financial assets with fixed or determinable payments that are not quoted in active markets. All transactions are recorded on the trade date. Transaction costs are expensed for FVTPL instruments and capitalized for all others. (iii) Derivative financial instruments The Company uses derivative financial instruments to manage exposure to foreign currency, equity and other market risks associated with certain assets and liabilities. Derivative financial assets and liabilities are classified as FVTPL. Therefore, they are initially recorded at fair value on the acquisition date and subsequently revalued at their fair value at each reporting date. Derivative financial instruments with a positive fair value are disclosed as Derivative assets while derivative financial instruments with a negative fair value are disclosed as Other liabilities. Changes in fair value are recorded in Fair value change in FVTPL assets in the Consolidated Statements of Operations. (iv) Impairment All investments other than FVTPL instruments are assessed for impairment at each reporting date. Impairment is recognized in Net income when there is objective evidence that a loss event has occurred which has impaired the estimated future cash flows of an asset. (1) AFS debt instruments An AFS debt instrument would be identified as impaired when there is objective evidence suggesting that timely collection of the contractual principal or interest is no longer reasonably assured. This may result from a breach of contract by the issuer, such as a default or delinquency in interest or principal payments, or evidence that the issuer is in significant financial difficulty. Impairment is recognized through Net income. Impairment losses previously recorded in Net income are reversed if the fair value subsequently increases and can be objectively related to an event occurring after the impairment loss was recognized. (2) AFS equity instruments Objective evidence of impairment of an equity instrument exists if there has been a significant or prolonged decline in the fair value of the investment below its cost or if there is a significant adverse change in the technological, market, economic or legal environment in which the issuer operates or the issuer is experiencing financial difficulties. The accounting for an impairment that is recognized in Net income is the same as described for AFS debt instruments above with the exception that impairment losses previously recognized in Net income cannot be subsequently reversed through Net income. Any subsequent increase in value is recorded in OCI. (3) Loans and receivables Mortgages and loans are individually evaluated for impairment in establishing the allowance for impairment. Empire Life - Annual Report 2019 47 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Objective evidence of impairment exists if there is no longer reasonable assurance of full collection of loan principal or loan interest related to a mortgage, policy contract loan or a loan on a policy. Events and conditions considered in determining if there is objective evidence of impairment include the value of the security underlying the loan, geographic location, industry classification of the borrower, an assessment of the financial stability and credit worthiness of the borrower, repayment history or an assessment of the impact of current economic conditions. If objective evidence of impairment is found, allowances for credit losses are established to adjust the carrying value of these assets to their net recoverable amount and the impairment loss is recorded in Net income. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be objectively related to an event occurring after the impairment was recognized, the impairment loss is reversed by adjusting the allowance account and the reversal is recognized in Net income. (v) Derecognition A financial asset is derecognized when the contractual rights to its cash flows expire or the Company has transferred its economic rights to the asset and substantially all risks and rewards. In instances where substantially all risks and rewards have not been transferred or retained, the assets are derecognized if the asset is not controlled through rights to sell or pledge the asset. (vi) Other Insurance receivables and trade accounts receivables have been classified as loans or receivables and are carried at amortized cost. Trade accounts receivables are presented as Other assets. Accounts payable and other liabilities (excluding derivative liabilities) and Insurance payables have been classified as other financial liabilities and are carried at amortized cost. For these financial instruments, carrying value approximates fair value due to their short term nature. (vii) Securities lending The Company engages in securities lending through its custodian as lending agent. Loaned securities are not derecognized and continue to be reported within Investments in the Consolidated Statements of Financial Position, as the Company retains substantial risks and rewards and economic benefits related to the loaned securities. For further details, refer to Note 3(e). (e) Reinsurance The Company enters into reinsurance agreements in order to limit its exposure to significant losses. The Company has a Reinsurance Risk Management policy which requires that such arrangements be placed with well-established, highly rated reinsurers. Reinsurance is measured consistently with the amounts associated with the underlying insurance contracts and in accordance with the terms of each reinsurance treaty. Amounts due to or from reinsurers with respect to premiums received or claims paid are included in Insurance receivables and Insurance liabilities in the Consolidated Statement of Financial Position. Premiums for reinsurance ceded are presented as Premiums ceded to reinsurers in the Consolidated Statements of Operations. Reinsurance recoveries on claims incurred are recorded as Claims recovery from reinsurers in the Consolidated Statements of Operations. The reinsurers’ share of Insurance contract liabilities is recorded as Reinsurance assets or Reinsurance liabilities in the Consolidated Statements of Financial Position at the same time as the underlying insurance contract liability to which it relates. Reinsurance assets are reviewed for impairment at each reporting date or more frequently when an indication of impairment arises during the reporting year. Impairment occurs when objective evidence exists that not all amounts due under the terms of the contract will be received. If a reinsurance asset is determined to be impaired, it is written down to its recoverable amount and the impairment loss is recorded in the Consolidated Statements of Operations. Gains or losses on buying reinsurance are recognized in the Consolidated Statements of Operations immediately at the date of purchase and are not amortized. Empire Life - Annual Report 2019 48 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (f) Property and equipment Property and equipment comprises own use land, buildings, leasehold improvements and furniture and equipment. All classes of assets are carried at cost less accumulated amortization including any impairment losses, except for land, which is not subject to amortization. Cost includes all expenditures that are directly attributable to the acquisition of an asset. Subsequent costs are included in the asset’s carrying amount only when it is probable that future economic benefits associated with the item will flow to the Company and the cost can be measured reliably. Amortization is calculated to write down the cost of property and equipment to their residual values over their estimated useful lives as follows: Land Building Furniture and equipment Leasehold improvements No amortization Five percent (declining balance) Three to five years (straight-line) Remaining lease term (straight-line) Amortization is included in Operating expenses in the Consolidated Statements of Operations. The estimated useful lives, residual values and amortization methods are reviewed at each year-end, with the effect of any changes in estimate accounted for on a prospective basis. Impairment reviews are performed when there are indicators that the carrying value may not be recoverable. An impairment loss is recognized for the amount by which the carrying value of the asset exceeds its expected recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use. Impairment losses are recognized in the Consolidated Statements of Operations. (g) Intangible assets Intangible assets include computer software, related licenses and software development costs, which are carried at cost less accumulated amortization and any impairment losses. Amortization of intangible assets is calculated using the straight-line method to allocate the costs over their estimated useful lives, which are generally between three and seven years. Amortization is included in Operating expenses in the Consolidated Statements of Operations. For intangible assets under development, amortization begins when the asset is available for use. The Company does not have intangible assets with indefinite useful lives. Changes in the expected useful life or the expected pattern of consumption of future economic benefits embodied in the asset are accounted for by changing the amortization period or method, as appropriate, and are treated as changes in accounting estimates. Impairment reviews are performed when there are indicators that the carrying value may not be recoverable. An impairment loss is recognized for the amount by which the carrying value of the asset exceeds its expected recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable cash flows. Impairment losses are recognized in the Consolidated Statements of Operations. Empire Life - Annual Report 2019 49 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (h) Investment in Associates Associates are entities over which the Company has significant influence but not control, generally accompanying a shareholding of between 20% and 50% of the voting rights. Investments in associates are accounted for using the equity method of accounting. Under the equity method, the investment is initially recognized at cost, and the carrying amount is increased or decreased to recognize the investor’s share of the income or loss of the investee after the date of acquisition. The Company’s share of post-acquisition income or loss is recognized in the Consolidated Statements of Operations, and its share of OCI is recognized in the Consolidated Statements of Comprehensive Income. The Company determines at each reporting date whether there is any objective evidence that each investment in associates is impaired. The Company calculates the amount of impairment as the difference between the recoverable amount of the associate and its carrying value and recognizes the amount as share of income (loss) of associates in the Consolidated Statements of Operations. Income and losses resulting from transactions between the Company and its associates are recognized in the Company’s financial statements only to the extent of unrelated investor’s interests in the associates. Unrealized losses are eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of associates have been changed where necessary to ensure consistency with the policies adopted by the Company. (i) Segregated funds Certain insurance contracts allow the policyholder to invest in segregated investment funds managed by the Company for the benefit of these policyholders. Although the underlying assets are registered in the Company's name and the policyholder has no direct access to the specific assets, the contractual arrangements are such that the segregated fund policyholder bears the risk and rewards of the fund's investment performance. Segregated fund assets are not available to pay liabilities of the general fund. The assets of these funds are carried at their period-end fair values. The Company records a segregated fund policy liability equal to the fair value of the assets and any guarantees are recorded as an insurance contract liability. The Company's Consolidated Statements of Operations includes fee income earned for management of the segregated funds, as well as expenses related to the acquisition, investment management, administration and death benefit, maturity benefit and withdrawal guarantees of these funds. See Note 8 for details on segregated fund assets and changes in segregated fund assets. The Company provides minimum guarantees on certain segregated fund contracts. These include minimum death, maturity and withdrawal benefit guarantees which are accounted for as insurance contracts. The actuarial liabilities associated with these minimum guarantees are recorded within Insurance contract liabilities. Sensitivity of the Company’s liability for segregated fund guarantees to market fluctuations is disclosed in Note 27(a)(1). (j) Subordinated debt Subordinated debt is recorded at amortized cost using the effective interest rate method. Interest on subordinated debt is reported as Interest expense in the Consolidated Statements of Operations. (k) Employee benefits The Company provides employee pension benefits through either a defined benefit or a defined contribution component of its pension plan. The Company discontinued new enrolments in the defined benefit component effective October 1, 2011 and introduced a defined contribution component effective January 1, 2012 for new enrolments and for any existing employees who chose to transfer from the defined benefit component. The Company also provides other post-employment benefits. (i) Pension benefits The defined benefit plan defines an amount of pension benefit that an employee will receive on retirement, dependent on factors such as age, years of service and compensation. The liability recognized in the balance sheet in respect of the defined benefit component is the present value of the defined benefit obligation at the end of the reporting period less the fair value of plan assets. The defined benefit obligation is calculated annually by independent actuaries using the projected unit Empire Life - Annual Report 2019 50 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) credit method. The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows using current interest rates of high-quality corporate bonds. Defined benefit expense includes the net interest on the net defined benefit liability (asset) calculated using a discount rate based on market yields on high quality bonds as of prior-year end. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are charged or credited to OCI in the period in which they arise, and remain in accumulated other comprehensive income (AOCI). Past-service costs are recognized immediately in net income. The defined contribution component of the Plan is a component under which the Company pays fixed contributions into a separate entity. The Company has no legal or constructive obligations to pay further contributions if the fund does not hold sufficient assets to pay employees the benefits relating to employee service in the current and prior periods. The contributions are recognized as employee benefit expense when they are due. (ii) Other post-employment benefits The Company also provides other post-employment benefits to their retirees. The entitlement to these benefits is conditional on the employee remaining in service up to retirement age and the completion of a minimum service period. The expected costs of these benefits are accrued over the period of employment using the same accounting methodology as used for defined benefit pension plans. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are charged or credited to OCI in the period in which they arise and remain in AOCI. These obligations are valued annually by independent actuaries and are not funded. (iii) Termination benefits Termination benefits are payable when employment is terminated before the normal retirement date or whenever an employee accepts voluntary redundancy in exchange for these benefits. The Company recognizes termination benefits when it is demonstrably committed to either terminating the employment of current employees according to a detailed formal plan without realistic possibility of withdrawal or providing termination benefits as a result of an offer made to encourage voluntary redundancy. (l) Insurance and investment contracts (i) Product classification Insurance contracts are those contracts that transfer significant insurance risk at the inception of the contract. Insurance risk is transferred when the Company agrees to compensate a policyholder if a specified uncertain future event (other than a change in a financial variable) adversely affects the policyholder and the insurance contract has commercial substance. Any contracts not meeting the definition of an insurance contract under IFRS are classified as investment contracts or service contracts, as appropriate. Products issued by the Company that transfer significant insurance risk have been classified as insurance contracts in accordance with IFRS 4 Insurance Contracts. Otherwise, products issued by the Company are classified as either investment contracts in accordance with IAS 39 Financial Instruments: Recognition and Measurement or service contracts in accordance with IFRS 15 Revenue from Contracts with Customers. The Company defines significant insurance risk as the possibility of paying at least 2% more than the benefits payable if the insured event did not occur. When referring to multiple contract types, the Company uses the terminology policy liabilities. Once a contract has been classified as an insurance contract, it remains an insurance contract for the remainder of its lifetime, even if the insurance risk reduces significantly during this period, unless all rights and obligations are extinguished or expire. Investment contracts, however, can be reclassified as insurance contracts after inception if insurance risk becomes significant. The Company classifies its insurance and investment contracts into three main categories: short-term insurance contracts, long-term insurance contracts and investment contracts. Empire Life - Annual Report 2019 51 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (1) Insurance contracts The Company’s insurance contract liabilities are determined using accepted actuarial practices according to standards established by the Canadian Institute of Actuaries (CIA) and the requirements of OSFI. The Company uses CALM for valuation of insurance contracts, which satisfies the IFRS 4 Insurance Contracts requirements for eligibility for use under IFRS. (a) Short-term insurance contracts These contracts include both annuity products and group benefits. The annuity products classified as short-term insurance contracts are guaranteed investment options that provide for a fixed rate of return over a fixed period. Contracts include certain guarantees that are initiated upon death of the annuitant. The liabilities are determined using CALM. The group benefits classified as short-term insurance contracts include short-term disability, health and dental benefits. Benefits are typically paid within one year of being incurred. Liabilities for unpaid claims are estimated using statistical analysis and Company experience for claims incurred but not reported. (b) Long-term insurance contracts These contracts include insurance products, annuity products and group benefits. In all cases, liabilities represent an estimate of the amount that, together with estimated future premiums and investment income, will be sufficient to pay future benefits, dividends, expenses and premium taxes on policies in force. The insurance products so classified are life insurance and critical illness that provide for benefit payments related to death, survival or the occurrence of a critical illness. Terms extend over a long duration. The annuity products classified as long-term insurance contracts include both annuities that provide for income payments for the life of the annuitant and guarantees associated with the Company’s segregated fund products. The group benefits classified as long-term insurance contracts are life benefits which are payable upon death of the insured and disability benefits that provide for income replacement in case of disability. The determination of long-term insurance contract liabilities requires best estimate assumptions that cover the remaining life of the policies. Due to the long-term risks and measurement uncertainties inherent in the life insurance business, a margin for adverse deviation from best estimates is included in each assumption. These margins allow for possible deterioration in future experience and provide for greater confidence that insurance contract liabilities are adequate to pay future benefits. The resulting provisions for adverse deviation have the effect of increasing insurance contract liabilities and decreasing the income that otherwise would have been recognized at policy inception. Assumptions are reviewed and updated at least annually and the impact of changes in those assumptions is reflected in Gross change in insurance contract liabilities and/or Change in insurance contract liabilities ceded in the Consolidated Statements of Operations in the year of the change. Annually, the Appointed Actuary determines whether insurance contract liabilities (for both short-term and long-term categories) are sufficient to cover the obligations and deferred acquisition costs that relate to policies in force as at the date of the Consolidated Statements of Financial Position. A number of valuation methods are applied, including CALM, discounted cash flows and stochastic modeling. Aggregation levels and the level of prudence applied in assessing liability adequacy are consistent with requirements of the CIA. Any adjustment is recorded as a Gross change in insurance contract liabilities and/or Change in insurance contract liabilities ceded in the Consolidated Statements of Operations. Empire Life - Annual Report 2019 52 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (2) Investment contracts These contracts include annuity products that do not involve the transfer of significant insurance risk, either at inception or during the life of the contract. For the Company, products so classified are limited to term certain annuities that provide for income payments for a specified period of time. Investment contract liabilities are recognized when contracts are entered into and deposits are received. These liabilities are initially recognized at fair value, and subsequently they are carried at amortized cost based on expected future cash flows using the effective interest rate method. The expected future cash flows are re-estimated at each reporting date and the carrying amount of the financial liability is recalculated as the present value of estimated future cash flows using the financial liability’s original effective interest rate. Any adjustment is immediately recognized in the Consolidated Statements of Operations. Deposits and withdrawals are recorded in Investment contract liabilities on the Consolidated Statements of Financial Position. (ii) Premiums Gross premiums for all types of insurance contracts are recognized as revenue when due and collection is reasonably assured. When premiums are recognized, policy liabilities are computed, with the result that benefits and expenses are matched with such revenue. Annuity premiums are comprised solely of new deposits on general fund products with a guaranteed rate of return and exclude deposits on segregated fund and investment contract products. (iii) Benefits and claims paid Benefits are recorded as an expense when they are incurred. Annuity payments are expensed when due for payment. Health insurance claims are accounted for when there is sufficient evidence of their existence and a reasonable assessment can be made of the monetary amount involved. Benefits and claims paid include the direct costs of settlement. Reinsurance recoveries are accounted for in the same period as the related claim. (iv) Deferred acquisition costs Distribution costs of segregated funds having a deferred sales charge are deferred and amortized over the term of the related deposits or the applicable period of such sales charge, as appropriate. These deferred costs form part of Insurance contract liabilities on the Consolidated Statements of Financial Position. The costs deferred in the period and amortization of deferred costs form part of the Gross change in insurance contract liabilities on the Consolidated Statements of Operations. (m) Participating policies The Company maintains an account in respect of participating policies (“participating account”), separate from those maintained in respect of other policies, in the form and manner determined by OSFI under sections 456-464 of the Insurance Companies Act. The participating account includes all policies issued by the Company that entitle its policyholders to participate in the profits of the participating account. The Company has discretion as to the amount and timing of dividend payments which take into consideration the continuing solvency of the participating account. Dividends are paid annually, with a few older plans paying dividends every five years as per contractual provisions. Participating policyholder dividends are recognized as Policy dividends expense in the Consolidated Statements of Operations. At the end of the reporting period all participating insurance contract liabilities, both guaranteed and discretionary, are held within Insurance contract liabilities, Policyholders’ funds on deposit and Provision for profits to policyholders. All participating policy reinsurance ceded at the end of the reporting period is held within Reinsurance assets or Reinsurance liabilities. Net income attributable to participating policyholders is shown on the Consolidated Statements of Operations. Comprehensive income attributable to participating policyholders is shown on the Consolidated Statements of Comprehensive Income. The portion of Retained earnings and Accumulated other comprehensive income (AOCI) in respect of participating policies is reported separately in the Policyholders’ equity section of the Consolidated Statements of Changes in Equity. Empire Life - Annual Report 2019 53 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (i) Investment policy The investments in the participating account are subject to limits established by the Insurance Companies Act and to investment guidelines established by the Investment Committee of the Board. The investment guidelines are designed to limit overall investment risk by defining investment objectives, eligible investments, diversification criteria, exposure, concentration and asset quality limits for eligible investments. Interest rate risk is managed through Investment Committee established limits and regular reporting by management to the Investment Committee and the Board. The Asset Management Committee oversees sensitivity to interest rates. The objective is to maximize investment yields while managing the default, liquidity and reinvestment risks at acceptable and measurable low levels. (ii) Investment income allocation Investment income is recorded directly to each asset segment. When there is a deficiency of funds over assets, a portion of investment income is allocated to the Shareholders’ Capital and Surplus segment from the participating account’s asset segments in proportion to the deficiency of funds over assets of each segment. When there is an excess of funds over assets, a portion of investment income is allocated from the Shareholders’ Capital and Surplus segment to the participating account’s asset segments in proportion to the excess of funds over assets of each segment. (iii) Expense allocation For purposes of allocation of profits to the participating account, expenses associated directly with the participating account will be attributed to the participating account. Expenses arising from or varying directly with various functional activities are charged to the participating account in proportion to statistics appropriate to each cost centre. Expenses incurred by overhead cost centres are charged to the participating account in proportion to expenses directly charged. Investment expenses are allocated monthly to the participating account in proportion to the Company’s total funds at the beginning of each month. Premium taxes are allocated in proportion to taxable premiums. Other taxes, licenses, and fees are allocated to lines of business using cost centre methods. (iv) Income tax allocation For the purpose of allocation of profits to the participating account, income taxes are allocated to the participating account in proportion to total taxable income for the Company. (n) Fee income Fee income includes investment management, policy administration and guarantee fees that are recognized on an accrual basis, and surrender charges that are recognized as incurred. Fee income earned for investment management, administration and guarantees of the investment funds is based on the funds’ closing net asset values. (o) Investment income Interest income is recognized using the effective interest rate method. Fees that are an integral part of the effective yield of the financial asset are recognized as an adjustment to the effective interest rate of the instrument. Dividend income is recognized when the right to receive payment is established, which is usually the ex- dividend date. Interest income and dividend income are included in Investment income in the Consolidated Statements of Operations for all financial assets. (p) Income taxes Income tax expense for the period is comprised of current and deferred tax. Tax is recognized in the Consolidated Statements of Operations except to the extent that it relates to items recognized in OCI or directly in equity. In these cases, the tax is recognized in OCI or directly in equity, respectively. Empire Life - Annual Report 2019 54 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Current tax assets and liabilities for the current and prior periods are measured at the amount expected to be recovered from or paid to the taxation authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted at the end of each reporting period. Deferred income tax assets and liabilities are recorded for the expected future income tax consequences of events that have been reflected in the consolidated financial statements. Deferred income taxes are provided for using the liability method. Under the liability method, deferred income taxes are recognized for all significant temporary differences between tax and financial statement bases for assets and liabilities and for certain carry-forward items. Deferred income tax assets are recognized only to the extent that, in the opinion of management, it is probable that the deferred income tax assets will be realized. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates, on the date of their substantive enactment. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets and they relate to income taxes levied by the same tax authority on the same taxable entity. (q) Foreign currency translation The Company uses the Canadian dollar as both its functional and presentational currency. Foreign currency transactions are accounted for at the exchange rates prevailing at the date of the transactions. Gains and losses resulting from the settlement of such transactions, and from the translation of monetary assets and liabilities denominated in foreign currencies, are recognized in the Consolidated Statements of Operations. For monetary financial assets designated as AFS, translation differences are recognized in the Consolidated Statements of Operations. Translation differences on non-monetary items, such as foreign denominated AFS common equities, are recognized in OCI and included in the AFS component within AOCI. On derecognition of an AFS non-monetary financial asset, the cumulative exchange gain or loss previously recognized in AOCI is recognized in the Consolidated Statements of Operations. (r) Comprehensive income Comprehensive income consists of Net income and OCI. OCI includes items that may be reclassified subsequently to Net income: Unrealized fair value change on AFS investments, net of amounts reclassified to net income and the Amortization of loss on derivative investments designated as cash flow hedges. OCI also includes items that will not be reclassified to net income: Remeasurements of post- employment benefit liabilities. All OCI amounts are net of taxes. (s) Provisions Provisions are recognized when the Company has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. If the outflow of economic benefits is not probable, a contingent liability is disclosed unless the possibility of an outflow of economic benefits is remote. Any change in estimate of a provision is recorded in Net income. Provisions are not recognized for future operating losses. Provisions are measured as the present value of the expected expenditures to settle the obligation using a discount rate that reflects current market assessments of the time value of money and the risks specific to the obligation. (t) Leases The Company leases certain property and equipment. When the Company enters into a lease as a lessee, a right-of-use asset and a lease liability is recognized in the Statements of Financial Position. The initial lease liability is computed based on the present value of the lease payments, discounted at the Company's incremental borrowing rate. Subsequent to the initial recognition the lease liability is measured at the amortized cost using the effective interest rate method and is included in Accounts payable and Empire Life - Annual Report 2019 55 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) other liabilities. Interest expense is included in operating expenses. The depreciation on the corresponding right-of-use asset is included in operating expenses. The Company has elected to apply the option to recognize lease payments for short-term and low level assets on a straight-line basis over the lease term in operating expenses. (u) Earnings per share (EPS) Basic EPS is calculated by dividing the Net income for the period attributable to common shareholders of the Company by the weighted average number of common shares outstanding during the period. The Company does not have any potentially dilutive instruments. As a result, diluted EPS are the same as basic EPS. (v) Accounting changes (i) New accounting pronouncements adopted in 2019 IFRS 16 Leases The Company adopted IFRS 16 effective January 1, 2019. The standard requires the capitalization of leases by recognizing the present value of the lease payments and showing them as lease assets, and recognizing a financial liability representing an obligation to make future lease payments. The Company elected to adopt IFRS 16 using the modified retrospective approach and comparative amounts have not been restated. The comparative information remains as previously reported under IAS 17. The adoption of IFRS 16 on January 1, 2019 did not have a significant impact on the Company's Consolidated Financial Statements. (ii) New accounting pronouncements issued but not yet effective (1) IFRS 9 Financial Instruments IFRS 9, effective for periods beginning on or after January 1, 2018 with retrospective application replaces IAS 39 Financial Instruments: Recognition and Measurement with a new mixed measurement model having three measurement categories of amortized cost, fair value through other comprehensive income (FVTOCI) and FVTPL for financial assets. Under IFRS 9, all financial assets currently within the scope of IAS 39 will be measured at either amortized cost, FVTOCI or FVTPL. Classification will depend on the business model and the contractual cash flow characteristics of the financial asset. All equity instruments will be measured at FVTOCI or FVTPL. A debt instrument will be measured at amortized cost only if it is held to collect the contractual cash flows and the cash flows represent principal and interest. For financial liabilities designated as FVTPL, the change in the fair value attributable to changes in the liability’s credit risk will be recognized in OCI. On September 12, 2016, the IASB published an amendment to IFRS 4 Insurance Contracts (which will be subsequently changed to IFRS 17 Insurance Contracts). The amendment provides two options for insurance companies relating to IFRS 9: • • a temporary exemption from IFRS 9 for entities that meet specific requirements (applied at the reporting entity level); and the ‘overlay approach’. The Company has evaluated the criteria and will apply the temporary exemption for periods beginning before January 1, 2022, which allows continued application of IAS 39 instead of adopting IFRS 9, if the Company’s activities are ‘predominantly connected with insurance’. OSFI has also mandated that all Federally Regulated Life Insurance Companies defer the application of IFRS 9 until IFRS 17 is adopted. Empire Life - Annual Report 2019 56 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Per the amendments to IFRS 4 Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts, companies applying the temporary exemption are required to disclose fair value information with respect to their investments in financial assets whose contractual cash flows reflect solely payments of principal and interest on the principal amount outstanding (SPPI), to enable users of financial statements to compare insurers applying the temporary exemption with entities applying IFRS 9. The Company’s fixed income invested assets presented in Note 3(a) include cash equivalents, short-term investments, bonds, mortgages, loans on policies and policy contract loans and primarily have cash flows that qualify as SPPI. Fixed income invested assets which do not have SPPI qualifying cash flows as at December 31, 2019 and December 31, 2018 include mortgages with fair values of $10.4 million and $11.5 million, respectively. The Company is currently evaluating the impact of IFRS 9 on its Consolidated Financial Statements. (2) IFRS 17 Insurance Contracts In May 2017, the IASB issued IFRS 17 Insurance Contracts, which provides a comprehensive principle-based framework for the recognition, measurement, presentation and disclosures of all insurance contracts. The new standard will replace IFRS 4 Insurance contracts. IFRS 17 requires entities to measure insurance contract liabilities at their current fulfillment cash flows and for revenue to be recognized as the service is provided over the coverage period. This new standard is expected to be effective for Empire Life on January 1, 2022 and is required to be adopted retrospectively, if this is impracticable, the modified retrospective or fair value method may be used. In June 2019, the IASB issued an exposure draft to amend IFRS 17, including deferral of the effective date by one year (to January 1, 2022). The exposure draft comment period ended on September 24, 2019 and the IASB plans to publish a final standard by mid-2020. The Company will continue to monitor the IASB’s developments. The Company is currently assessing the impact of adopting this standard and the proposed amendments on its Consolidated Financial Statements. Empire Life - Annual Report 2019 57 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 3. Financial Instruments (a) Summary of Cash and cash equivalents and investments The carrying values of cash and cash equivalents and investments are as follows: As at December 31 2019 Fair value through profit or loss Available for sale Total carrying value Fair value through profit or loss 2018 Available for sale Asset category Cash and cash equivalents Cash Cash equivalents Total cash and cash equivalents Short-term investments Canadian federal government Canadian provincial governments Canadian municipal governments Corporate Total short-term investments Bonds Canadian federal government Canadian provincial governments Canadian municipal governments Total Canadian government bonds Canadian corporate bonds by industry sector: Energy Materials Industrials Consumer discretionary Consumer staples Health care Financial services Communication services Utilities Real estate Infrastructure $ 20,698 $ — $ 20,698 $ 11,418 $ — $ 119,635 140,333 13,988 6,463 897 11,036 32,384 106,106 3,706,755 106,418 3,919,279 107,996 15,799 61,155 15,263 130,116 87,721 615,089 181,108 479,903 18,145 319,442 — — — — — — — 226,594 475,970 102,340 804,904 60,018 6,822 66,411 991 65,905 22,081 296,760 75,261 99,925 18,591 30,810 119,635 140,333 193,503 204,921 13,988 6,463 897 11,036 32,384 9,990 5,983 — 7,997 23,970 332,700 89,389 4,182,725 3,109,456 208,758 97,472 4,724,183 3,296,317 168,014 22,621 127,566 16,254 196,021 109,802 911,849 256,369 579,828 36,736 350,252 70,013 10,321 81,682 21,223 113,693 78,384 571,147 108,548 362,577 6,549 265,320 — — — 3,989 — — 3,989 184,088 490,369 77,965 752,422 69,565 — 69,933 19,024 79,978 21,183 323,960 76,251 67,710 31,956 23,378 Total carrying value 11,418 193,503 204,921 9,990 9,972 — 7,997 27,959 273,477 3,599,825 175,437 4,048,739 139,578 10,321 151,615 40,247 193,671 99,567 895,107 184,799 430,287 38,505 288,698 Total Canadian corporate bonds 2,031,737 743,575 2,775,312 1,689,457 782,938 2,472,395 Total foreign bonds Total bonds 10,157 — 10,157 8,946 — 8,946 5,961,173 1,548,479 7,509,652 4,994,720 1,535,360 6,530,080 Total preferred shares - Canadian 463,826 10,203 474,029 384,760 11,100 395,860 Common shares Canadian common shares Exchange-traded funds Canadian real estate limited partnership units U.S. Other Total common shares Total derivative assets 111,461 494,131 120,884 42,306 29,000 797,782 2,930 44,247 — — — — 44,247 — 155,708 494,131 120,884 42,306 29,000 842,029 2,930 553,337 51,813 605,150 — 110,324 37,439 41,503 742,603 10,424 — — 55 652 52,520 — — 110,324 37,494 42,155 795,123 10,424 Empire Life - Annual Report 2019 58 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Loans and receivables Mortgages Loans on policies Policy contract loans — — — — — — 169,827 55,363 66,520 — — — — — — 193,074 51,949 69,180 Total financial instruments $ 7,398,428 $ 1,602,929 $ 9,293,067 $ 6,361,398 $ 1,602,969 $ 8,278,570 The following table presents the fair value of cash and cash equivalents and investments classified by the fair value hierarchy: As at December 31 2019 2018 Level 1 Level 2 Total fair value Level 1 Level 2 Fair value through profit or loss: Cash and cash equivalents $ 20,698 $ 119,635 $ 140,333 $ 11,418 $ 193,503 $ — — 32,384 32,384 5,961,173 5,961,173 463,826 676,858 2,928 — — 10,203 44,247 — — — — 120,924 2 — 463,826 797,782 2,930 — 1,548,479 1,548,479 — — 175,229 55,363 66,520 10,203 44,247 175,229 55,363 66,520 — — 384,760 631,961 9,760 — — 11,100 52,520 — — — Total fair value 204,921 23,970 23,970 4,994,720 4,994,720 — 110,642 664 384,760 742,603 10,424 3,989 3,989 1,535,360 1,535,360 — — 193,391 51,949 69,180 11,100 52,520 193,391 51,949 69,180 Short-term investments Bonds Preferred shares Common shares Derivative assets Available for sale: Short-term investments Bonds Preferred shares Common shares Loans and Receivables Mortgages Loans on policies Policy contract loans Total $ 1,218,760 $ 8,079,709 $ 9,298,469 $ 1,101,519 $ 7,177,368 $ 8,278,887 The fair value of mortgages has been calculated by discounting cash flows of each mortgage at a discount rate appropriate to its remaining term to maturity. The discount rates are determined based on regular competitive rate surveys. The fair values of Loans on policies and Policy contract loans approximates their carrying values, due to the life insurance contracts that secure them. The classification of a financial instrument into a level is based on the lowest level of input that is significant to the determination of the fair value. There were no transfers between Level 1 and Level 2 and there were no Level 3 investments during the year ended December 31, 2019 or during the year ended December 31, 2018. For additional information on the composition of the Company’s invested assets and analysis of the Company’s risks arising from financial instruments refer to Note 27 Risk Management. Empire Life - Annual Report 2019 59 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (b) Impairments (i) Loans and receivables Investments in individual assets have been reduced by the following specific allowances for impairment: As at December 31 Impaired Loans Mortgages Policy contract loans Total 2019 2018 Recorded investment Allowance for impairment Carrying value Recorded investment Allowance for impairment Carrying value $ $ 5,531 $ 2,678 $ 2,853 $ 6,424 $ 2,896 $ 813 460 353 813 478 6,344 $ 3,138 $ 3,206 $ 7,237 $ 3,374 $ 3,528 335 3,863 The Company holds collateral with a fair value of $2,854 (2018 $3,590) in respect of these mortgages and $353 (2018 $335) in respect of these policy contract loans as at December 31, 2019. Mortgage loans are secured by real estate, and policy contract loans are secured by life insurance. For the year ended December 31 Continuity of allowance for loan impairment: Allowance - beginning of year Provision for loan impairment Write-off of loans Allowance - end of year 2019 2018 3,374 $ 634 (870) 3,138 $ 3,474 333 (433) 3,374 $ $ The Company has recorded interest income of $669 (2018 $753) on these assets. (ii) Available for sale For the year-ended December 31, 2019, the Company reclassified a pre-tax loss of $1,811 (2018 $1,658) from OCI to Net income due to write downs of impaired AFS common and preferred shares. Management considers these assets to be impaired due to the length of time that the fair value was less than the cost and/or the extent and nature of the loss. For additional information on the fair values of the Company’s AFS investments, refer to Note 3(a). For analysis of the Company’s risks arising from financial instruments, refer to Note 27. (c) Investment income Investment income is comprised of the following: For the year ended December 31 Interest income Dividend income Other Provision for loan impairment Investment income 2019 276,364 $ 49,592 395 (634) 2018 261,218 46,987 556 (333) 325,717 $ 308,428 $ $ Interest income includes $66,265 (2018 $64,893) relating to assets not classified as FVTPL. Empire Life - Annual Report 2019 60 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (d) Derivative financial instruments The values of derivative instruments are set out in the following table. The use of derivatives is measured in terms of notional principal amounts, which serve as the basis for calculating payments and are generally not actual amounts that are exchanged. As at December 31 Exchange-traded Notional principal 2019 Fair value assets Fair value liabilities Notional principal 2018 Fair value assets Fair value liabilities Equity index futures $ 49,964 $ Equity options Over-the-counter Foreign currency forwards Cross currency swaps 537,772 37,103 20,980 585 $ 2,342 28 $ — 42,968 $ 431,459 458 $ 9,302 3 — 402 1,610 32,896 16,839 664 — Total $ 645,819 $ 2,930 $ 2,040 $ 524,162 $ 10,424 $ 53 — — 707 760 All contracts mature in less than one year. Fair value asset amounts are reported in the Consolidated Statements of Financial Position as Derivative assets. Fair value liability amounts are reported in the Consolidated Statements of Financial Position as part of Accounts payable and other liabilities. Fair value of exchange traded derivatives is determined based on Level 1 inputs. Foreign currency forward contracts are valued based primarily on the contract notional amount, the difference between the contract rate and the forward market rate for the same currency, interest rates and credit spreads. Cross currency swaps are valued by discounting the future cash flows for both legs at the underlying market interest rate curves in each currency applicable at the valuation date. The sum of the cash flows denoted in the foreign currency is converted with the spot rate applicable at that time. The foreign currency leg, where Empire Life owes interest and principal, produces a negative fair value to Empire Life while the Canadian dollar leg produces a positive fair value to Empire Life. The net of these amounts represents the reported fair value of the cross currency swap. Contracts for which counterparty credit spreads are observable and reliable, or for which the credit-related inputs are determined not to be significant to fair value, are classified as Level 2. For analysis of the Company’s risks arising from financial instruments, refer to Note 27. (e) Securities Lending The Company has a securities lending agreement with its custodian. Under this agreement, the custodian may lend securities from the Company’s portfolio to other institutions, as approved by the Company, for periods of time. In addition to a fee, the Company receives collateral which exceeds the market value of the loaned securities, which is retained by the Company until the underlying security has been returned to the Company. In the event that any of the loaned securities are not returned to the custodian, at its option the custodian may either restore to the Company securities identical to the loaned securities or it will pay to the Company the value of the collateral up to but not exceeding the market value of the loaned securities on the date on which the loaned securities were to have been returned (Valuation Date) to the custodian. If the collateral is not sufficient to allow the custodian to pay such market value to the Company, the custodian shall indemnify the Company only for the difference between the market value of the securities and the value of such collateral on the Valuation Date. As a result, there is no significant exposure to credit risk associated with this securities lending agreement. Income recognized from securities lending activities was as follows: For the year ended December 31 General funds Segregated funds Total $ $ 2019 986 $ 1,706 2,692 $ 2018 856 1,756 2,612 Empire Life - Annual Report 2019 61 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) As at December 31, 2019 and December 31, 2018, the aggregate fair values of the Company's securities loaned and the collateral received were as follows: As at December 31 2019 2018 General Funds Segregated Funds Total General Funds Segregated Funds Total Value of securities loaned Value of collateral received $ $ 1,184,675 $ 1,511,859 $ 2,696,534 $ 989,557 $ 1,282,600 $ 2,272,157 1,208,397 $ 1,542,231 $ 2,750,628 $ 1,009,925 $ 1,308,299 $ 2,318,224 4. Insurance Receivables As at December 31 Due from policyholders Due and accrued from reinsurers Fees receivable Other Insurance receivables 2019 3,047 $ 17,927 15,512 12,242 48,728 $ 2018 3,711 20,351 16,231 6,408 46,701 $ $ All amounts are expected to be recovered within one year of the Consolidated Statements of Financial Position date. These financial instruments are short-term in nature and their fair values approximate carrying values. 5. Other Assets Other assets consist of the following: As at December 31 Trade accounts receivable Prepaid expenses Right-of-use assets Other assets 2019 13,180 $ 6,231 3,685 23,096 $ 2018 14,326 5,876 — 20,202 $ $ All amounts are expected to be recovered within one year of the Consolidated Statements of Financial Position date except for right-of-use assets of $3,685 (2018 $nil). These financial instruments are short-term in nature and their fair values approximate carrying value. Empire Life - Annual Report 2019 62 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 6. Property and Equipment Cost As at January 1, 2018 Additions Disposals As at December 31, 2018 Additions Disposals As at December 31, 2019 Amortization As at January 1, 2018 Charge for the year Disposals As at December 31, 2018 Charge for the year Disposals As at December 31, 2019 Carrying amount December 31, 2019 December 31, 2018 $ $ $ $ $ $ Land Buildings Furniture and equipment Leasehold improvements 2,318 $ 13,038 $ 40,877 $ 8,056 $ — — 2,318 — — — — 13,038 1 — 2,889 — 43,766 2,255 — 235 — 8,291 719 — 2,318 $ 13,039 $ 46,021 $ 9,010 $ — $ (4,344) $ (26,771) $ (6,629) $ — — — — — (435) — (4,779) (413) — (4,346) — (31,117) (4,780) — (312) — (6,941) (342) — — $ (5,192) $ (35,897) $ (7,283) $ 2,318 $ 2,318 $ 7,847 $ 8,259 $ 10,124 $ 12,649 $ 1,727 $ 1,350 $ Total 64,289 3,124 — 67,413 2,975 — 70,388 (37,744) (5,093) — (42,837) (5,535) — (48,372) 22,016 24,576 There were no asset impairments in 2019 or 2018. 7. Intangible Assets Cost As at January 1, 2018 Additions Disposals As at December 31, 2018 Additions Disposals As at December 31, 2019 Amortization As at January 1, 2018 Charge for the year Disposals As at December 31, 2018 Charge for the year Disposals As at December 31, 2019 Carrying amount December 31, 2019 December 31, 2018 There were no asset impairments during 2019 or 2018. Empire Life - Annual Report 2019 63 Intangible assets $ $ $ $ $ $ 62,892 3,862 — 66,754 8,993 — 75,747 (44,582) (4,368) — (48,950) (4,440) — (53,390) 22,357 17,804 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 8. Segregated Funds (a) The following table identifies segregated fund assets by category of asset: As at December 31 Cash Short-term investments Bonds Common and preferred shares Other assets $ 2019 8,482 $ 595,621 1,857,955 6,100,714 13,577 8,576,349 2018 22,220 496,849 1,512,174 5,832,553 19,418 7,883,214 Less segregated funds held within general fund investments Total (77,766) (60,424) $ 8,498,583 $ 7,822,790 (b) The following table presents the investments of the segregated funds measured on a recurring basis at fair value classified by the fair value hierarchy: As at December 31 2019 2018 Level 1 Level 2 Total Level 1 Level 2 Total Cash Short-term investments Bonds $ 8,482 $ — $ 8,482 $ 22,220 $ — $ — — 595,621 1,857,955 — 595,621 1,857,955 6,100,714 — — 5,829,250 496,849 1,512,174 3,303 22,220 496,849 1,512,174 5,832,553 Common and preferred shares 6,100,714 Total $ 6,109,196 $ 2,453,576 $ 8,562,772 $ 5,851,470 $ 2,012,326 $ 7,863,796 There were no transfers between Level 1 and Level 2 during the years ended December 31, 2019 and December 31, 2018. There were no level 3 investments as at December 31, 2019 and December 31, 2018. (c) The following table presents the change in segregated fund assets: For the year ended December 31 Segregated fund assets - beginning of year Additions to segregated funds: Amount received from policyholders Interest Dividends Other income Net realized gains on sale of investments Net unrealized increase in fair value of investments Deductions from segregated funds: Amounts withdrawn or transferred by policyholders Net unrealized decrease in fair value of investments Management fees and other operating costs 2019 2018 $ 7,822,790 $ 8,681,892 1,245,819 1,267,114 64,909 165,247 23,061 251,403 756,655 59,600 176,659 29,832 179,498 — 2,507,094 1,712,703 1,571,091 — 242,868 1,813,959 1,387,872 913,433 249,859 2,551,164 Net change in segregated funds held within general fund investments (17,342) (20,641) Segregated fund assets - end of year $ 8,498,583 $ 7,822,790 Empire Life - Annual Report 2019 64 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (d) Empire Life's exposure to segregated fund guarantee risk Segregated fund products issued by Empire Life contain death, maturity, and withdrawal benefit guarantees. Market price fluctuations impact the Company's estimated liability for those guarantees. 9. Insurance Payables As at December 31 Claims due and accrued Payable to agents Premiums paid in advance Due to reinsurance companies Other Insurance payables 2019 37,551 $ 16,688 2,456 15,902 22,981 95,578 $ 2018 49,284 14,103 2,401 5,479 22,281 93,548 $ $ Of the above total, $969 (2018 $674) is expected to be settled more than one year after the Consolidated Statements of Financial Position date. Most of these financial instruments are short-term in nature and their fair value approximates carrying values. 10. Insurance Contract Liabilities and Reinsurance Assets/Liabilities (a) Nature and composition of insurance contract liabilities and related reinsurance Insurance contract liabilities include life, health and annuity contracts on a participating and non-participating basis. Changes in actuarial assumptions are made based on emerging and evolving experience with respect to major factors affecting estimates of future cash flows and consideration of economic forecasts of investment returns, industry studies and requirements of the CIA and OSFI. Insurance contract liabilities represent an estimate of the amount that, together with estimated future premiums and investment income, will be sufficient to pay future benefits, dividends, expenses, and premium taxes on policies in force. Insurance contract liabilities are determined using accepted actuarial practice according to standards established by the CIA and the requirements of OSFI. The Company reinsures excess risks with Canadian regulated reinsurance companies. The reinsurance assets (liabilities) are determined based on both the premiums expected to be paid by the Company under reinsurance agreements over the duration of the insurance contracts that they support and the insurance claims expected to be received by the Company when an insured event occurs under those insurance contracts. The liability position of some of the reinsurance is due to the excess of future premiums payable over the expected benefit of reinsurance. The change in reinsurance liabilities is primarily related to the Company's revised mortality assumptions, which reduce the present value of insurance claims expected to be recovered from the reinsurance companies. The Company enters into reinsurance agreements only with reinsurance companies that have an independent credit rating of "A-" or better from A.M. Best. Reinsurance transactions do not relieve the original insurer of its primary obligation to policyholders. Empire Life - Annual Report 2019 65 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The Company is active in most life insurance and annuity product lines across Canada and does not operate in foreign markets. The table below shows the concentration of insurance contract liabilities and related reinsurance assets (liabilities) by type of contract: As at December 31 Participating Individual Life Annuity Non-participating Individual Life Health Annuity Non-participating Group Life Health Annuity 2019 Gross insurance contract liabilities Reinsurance (assets) liabilities Gross insurance contract liabilities Net 2018 Reinsurance (assets) liabilities Net $ 701,185 $ 10,313 $ 711,498 $ 621,201 $ 5,297 $ 626,498 138 — 138 134 — 134 4,013,248 797,015 4,810,263 3,286,264 875,443 4,161,707 243,562 902,530 28,499 223,926 44,838 (8,476) (8,875) 235,086 893,655 (1,345) (90,260) — — 27,154 133,666 44,838 204,459 891,048 23,548 192,597 44,689 (8,332) (10,689) 196,127 880,359 (915) (72,003) — — 22,633 120,594 44,689 (87,517) Segregated fund deferred acquisition costs (84,058) (84,058) (87,517) Total $ 6,073,868 $ 698,372 $ 6,772,240 $ 5,176,423 $ 788,801 $ 5,965,224 The Company expects to pay $5,996,977 (2018 $5,085,826) of Insurance contract liabilities and $704,339 (2018 $784,507) of Reinsurance liabilities more than one year after the Consolidated Statements of Financial Position date. The remaining balance is expected to be settled within one year. The following segregated fund deferred acquisition costs are included in Insurance contract liabilities: Segregated funds deferred acquisition costs - beginning of year Deferred during year Amortized during year Segregated funds deferred acquisition costs - end of year 2019 87,517 $ 25,872 (29,331) 84,058 $ 2018 94,329 26,213 (33,025) 87,517 $ $ Of the above total, $30,576 (2018 $31,610) is expected to be amortized during the next year. Empire Life - Annual Report 2019 66 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (b) Change in insurance contract liabilities and reinsurance assets/liabilities For the year ended December 31 2019 Gross insurance contract liabilities Reinsurance (assets) liabilities Gross insurance contract liabilities Net 2018 Reinsurance (assets) liabilities Net Balance - beginning of year $ 5,176,423 $ 788,801 $ 5,965,224 $ 5,364,865 $ 650,801 $ 6,015,666 Changes in methods and assumptions Non-participating policies Changes for expected mortality/ morbidity Update of mortality table Lapse/premium assumption updates Update of investment return assumptions Model enhancements and other changes Reinsurance recapture Participating policies Model enhancements and other changes Normal changes New business In-force business Balance - end of year (60,206) 137,622 31,968 47,618 (292,750) (5,393) (12,588) (155,128) 26,575 — 36,584 (152,206) 127,213 119,718 16,964 136,682 (3,900) 59,077 (3,084) 10,783 69,860 (103,486) (106,570) (6,797) — — 22,823 7,386 6,753 — (24,993) — 59,407 3,486 (44) — (9,634) 3,967 (5,667) (12,896) 3,436 (9,460) 31,649 590,335 2,292 229,576 33,941 819,911 41,738 (90,965) 4,357 46,095 (33,968) (124,933) $ 6,073,868 $ 698,372 $ 6,772,240 $ 5,176,423 $ 788,801 $ 5,965,224 Net changes in methods and assumptions summarized in the above tables are further explained as follows: Changes for expected mortality in 2019 are primarily related to revisions of the projected assumptions for individual life business, along with a smaller benefit from group long-term disability business. Changes in 2018 were due to similar updates, but were slightly offset by a small deterioration in mortality for immediate annuities. In 2019 the individual insurance mortality tables were replaced by more recent industry tables. The multipliers which are applied to the industry table were also updated based on a combination of Company and industry experience. This update results in a significant decrease to net liabilities. In 2019 the lapse/premium assumption change is primarily related to updates of assumed lapse rates on renewable term policies. In 2018 the lapse/premium assumption change was primarily related to refinements in expected policyholder persistency for universal life policies and updates in expected lapse rates on renewable term policies. The primary drivers of the update of investment return assumptions for 2019 were promulgated updates to the initial reinvestment rate (IRR) and ultimate reinvestment rate (URR) used in the valuation of policy liabilities. Updates were also made to the equity investment return assumption, the planned level of equities matching policy liabilities and to the maturity assumptions for preferred shares. The primary changes in the net investment return assumptions for 2018 were due to a refinement to the projection of equity assets backing the non-participating liability segment valuation at 2018 year-end, to reflect a reduced reliance on these assets in the future, with a corresponding increased reliance on fixed income instruments. This assumption change results in lower overall future yields and greater policy liabilities. This is offset by improved projected returns on related to reinvestment assumptions on projected future investable cash flows. Empire Life - Annual Report 2019 67 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Several model enhancements were implemented in 2019. These enhancements include updates to return of premium assumptions on Trilogy and Concordia policies, reinsurance model refinements, and refinements to the mortality projection. Model enhancements and other changes for 2018 are primarily related to enhancements to the modeling of reinsurance for individual life insurance as well as an update in the unit maintenance expense assumptions used in our projections. In 2019 Empire Life notified the reinsurers of our individual life policies that in 2020 the Company will increase its individual life retention from $500,000 to $1.5 million and the recapture provisions of all eligible reinsurance treaties would be enacted. Updates to the production valuation model to reflect the recapture resulted in a net liability decrease on both the universal life and non-participating blocks of business. (c) Mix of assets allocated to insurance, annuity, investment contract liabilities and equity Cash and cash equivalents & Short-term investments $ 119,451 $ 7,956 $ 1,816 $ 43,494 $ 172,717 As at December 31, 2019 Insurance liabilities Annuity liabilities Investment contract liabilities Equity and other liabilities Total Bonds Mortgages Preferred shares Common shares Derivative assets Loans on policies Policy contract loans Other Total 4,860,681 24,083 103,865 797,783 588 54,695 425 20,940 605,503 139,158 176,915 — — — 23,697 5,251 156,599 1,886,869 7,509,652 6,586 4,854 — — 668 — 643 — 188,395 44,246 2,342 — 42,398 142,305 169,827 474,029 842,029 2,930 55,363 66,520 169,139 $ 5,982,511 $ 958,480 $ 171,166 $ 2,350,049 $ 9,462,206 As at December 31, 2018 Insurance liabilities Annuity liabilities Investment contract liabilities Equity and other liabilities Total Cash and cash equivalents & Short-term investments $ 169,279 $ 9,491 $ 260 $ 53,850 $ 232,880 Bonds Mortgages Preferred shares Common shares Derivative assets Loans on policies Policy contract loans Other Total 4,158,384 33,214 33,978 761,181 1,122 51,949 1,495 22,874 544,822 149,767 177,337 — — — 22,758 5,083 14,908 1,811,966 6,530,080 4,098 4,852 — — — 623 139 5,995 179,693 33,942 9,302 — 44,304 140,241 193,074 395,860 795,123 10,424 51,949 69,180 168,337 $ 5,233,476 $ 909,258 $ 24,880 $ 2,279,293 $ 8,446,907 Provisions made for anticipated future losses of principal and interest on investments and included as a component of policy liabilities are $215,400 (2018 $189,300). (d) Fair value of insurance and investment contract liabilities and reinsurance assets/liabilities In the absence of an active market for the sale of insurance and investment contract liabilities and reinsurance assets/liabilities, the actuarially determined values provide a reasonable approximation of their fair value. Investment contract liabilities are term certain annuities with a relatively short duration. Empire Life - Annual Report 2019 68 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (e) Liquidity The Company defines liquid assets as high quality marketable investments that may be easily sold, meaning there exists an active market and observable prices for the investments. Liquid asset values are based on fair value as at the reporting date. The Company defines cash demands or demand liabilities as those policyholder obligations that may be called on immediately at the discretion of the policyholder. More specifically, demand liabilities include cash surrender values under whole life insurance products as well as current accumulated values of annuity products. Amounts would be gross of any surrender charge or market value adjustment allowed under the terms of the contract. Demand liabilities are determined as though all such policyholders made their call at the same time and as such cannot be readily compared to insurance contract liabilities that are determined based on actuarial assumptions associated with lapse as well as other decrements. The Company maintains a high level of liquid assets so that cash demands can be readily met. The Company’s liquidity position is as follows: As at December 31 Assets: Cash and cash equivalents & Short-term investments Canadian federal and provincial bonds Other readily-marketable bonds and stocks Total liquid assets Liabilities: Demand liabilities with fixed values Demand liabilities with market value adjustments Total liquidity needs 11. Accounts Payable and Other Liabilities Accounts payable and other liabilities consist of: As at December 31 Accounts payable Post-employment benefit liability (Note 12) Accrued interest on subordinated debt Derivative liabilities (Note 3d) Lease liabilities Other Accounts payable and other liabilities 2019 2018 $ $ $ $ $ $ 172,717 $ 4,515,425 3,484,991 8,173,133 $ 753,579 $ 1,219,282 1,972,861 $ 2019 39,011 $ 42,616 2,554 2,040 3,683 16,133 106,037 $ 232,880 3,873,302 3,129,406 7,235,588 702,440 1,169,807 1,872,247 2018 49,579 36,466 2,554 760 — 15,812 105,171 Of the above total, $42,616 (2018 $36,466) is expected to be settled more than one year after the Consolidated Statements of Financial Position date. In the absence of an active market for post-employment benefit liabilities, the actuarially determined value provides a reasonable approximation of fair value. Derivative liabilities are carried at fair value, as disclosed in Note 3(d). All other amounts are short-term in nature and their fair value approximates carrying value. Empire Life - Annual Report 2019 69 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 12. Employee Benefit Plans Empire Life sponsors pension and other post-employment benefit plans for eligible employees. The Empire Life Insurance Company Staff Pension Plan (the Plan) consists of a defined benefit component and a defined contribution component. The Company discontinued enrolments in the defined benefit component effective October 1, 2011. The Company has supplemental arrangements that provide defined pension benefits in excess of statutory limits. In addition to pension benefits, the Company also provides for post-employment health and dental care coverage and other future benefits to qualifying employees and retirees. The defined benefit component of the Plan is a final average salary pension plan, which provides benefits to members in the form of a guaranteed level of pension payable for life. The level of benefits provided depends on members’ age, length of service and their salary in the final years leading up to retirement. Pensions generally do not receive inflationary increases once in payment. In the past, however, the Company has provided ad-hoc pension increases on its defined benefit staff pension plan. Increases take place at the discretion of the Board. The pension benefit payments are from trustee-administered funds. The Company’s staff pension plan is governed by the Pension Benefits Act of the Province of Ontario, as amended, which requires that the plan sponsor fund the defined benefits determined under the plan. The Company’s supplemental employee retirement benefit plan is governed by provisions of the plan, which requires that the plan sponsor fund the defined benefits determined under the plan. The amount of funds contributed to these defined benefit pension plans by Empire Life is determined by an actuarial valuation of the Plans. Under the defined contribution component, contributions are made in accordance with the provisions of the Plan documents. A pension committee, composed of selected senior members of Empire Life's management and that of its parent, E-L Financial Corporation, oversees the Pension Plan of the Company. The Pension Committee reports to the Human Resources Committee of the Board three times each year. The Audit Committee of the Board approves the audited annual financial statements of the Pension Plan. The other post-employment benefit plan provides for health, dental care, and other future defined benefits to qualifying employees and retirees. It is unfunded and the Company meets the benefit payment obligation as it falls due. In the absence of an active market for post-employment benefit obligations, the actuarially determined values provide a reasonable approximation of their fair value. Plan assets are carried at fair value. The following tables present financial information for the Company’s defined benefit plans: As at December 31 Present value of obligations Fair value of plan assets Post-employment benefit asset (liability) Pension benefits Other post-employment benefits 2019 2018 2019 249,494 $ 220,129 $ 8,656 $ 215,534 192,015 — 2018 8,352 — (33,960) $ (28,114) $ (8,656) $ (8,352) $ $ The post-employment benefit asset (liability), net of the cumulative impact of the asset ceiling, is included in the Consolidated Statements of Financial Position in Accounts payables and other liabilities (Note 11). Empire Life - Annual Report 2019 70 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The movement in the present value of the defined benefit obligations over the year is as follows: Pension benefits Other post-employment benefits As at December 31 2019 2018 2019 Present value of defined benefit obligation - beginning of year $ 220,129 $ 227,019 $ 8,352 $ Current service cost Past service cost Interest expense Decrease (increase) in net income before tax Remeasurements (Gain) loss from changes in demographic assumptions (Gain) loss from changes in financial assumptions Actuarial (gain) loss from member experience Decrease (increase) in OCI before tax Employee contributions Benefits paid 5,978 3,967 8,331 18,276 — 22,878 (116) 22,762 1,397 (13,070) 6,597 — 8,040 14,637 — (8,891) (681) (9,572) 1,481 (13,436) — — 299 299 — 570 (282) 288 — (283) Present value of defined benefit obligation - end of year $ 249,494 $ 220,129 $ 8,656 $ The movement in the fair value of the Plan’s defined benefit assets over the year is as follows: 2018 9,697 — — 329 329 66 (638) (613) (1,185) — (489) 8,352 As at December 31 Fair value of defined benefit assets - at beginning of year Interest income Administrative expense Increase (decrease) in net income before tax Remeasurements Pension benefits 2019 2018 $ 192,015 $ 210,126 7,339 (243) 7,096 7,515 (195) 7,320 Return on plan assets, excluding amounts included in interest income 21,790 (17,030) Gain (loss) from changes in demographic assumptions Gain (loss) from changes in financial assumptions Actuarial gain (loss) from member experience Change in effect of asset limit Increase (decrease) in OCI before tax Plan transfers / curtailments Employer contributions Employee contributions Benefits paid Fair value of defined benefit assets - end of year — — — — — — — — 21,790 (17,030) 6,306 1,397 3,554 1,481 (13,070) (13,436) $ 215,534 $ 192,015 The actual return on defined benefit assets net of administrative expense, for the year ended December 31, 2019 was a gain of $28,886 (2018 loss of $9,710). Defined benefit plan expense is recognized in Operating expenses. Remeasurements in the defined benefit plan are included in OCI. Operating expenses also include $2,057 (2018 $1,691) of employer contributions related to the defined contribution component of the Plan. Expected contributions (including both employer and employee amounts) to the Company’s defined benefit pension plans for the year ending December 31, 2020 are approximately $4,721. Empire Life - Annual Report 2019 71 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The Plan invests primarily in Empire Life segregated and mutual funds. The fair value of the underlying assets of the funds and other investments are included in the following table: As at December 31 2019 2018 Equity Canadian Foreign Total equity Debt Canadian Cash, cash equivalent, accruals Mutual funds Other Total fair value of assets $ 75,336 50,977 126,313 65,194 6,711 8,312 9,005 35% $ 24% 59% 30% 3% 4% 4% $ 66,692 41,367 108,059 61,171 7,425 7,400 7,960 34% 22% 56% 32% 4% 4% 4% $ 215,535 100% 192,015 100% Fair value is determined based on Level 1 inputs for equities and Level 2 inputs for debt. The following weighted average assumptions were used in actuarial calculations: As at December 31 Defined benefit obligation as at December 31: Discount rate - defined benefit obligation Discount rate - net interest Rate of compensation increase Assumed health care cost trend rates at December 31: Initial health care cost trend rate Cost trend rate declines to Year ultimate health care cost trend rate is reached Pension benefits Other post-employment benefits 2019 2018 2019 2018 3.15% 3.85% 3.0% n/a n/a n/a 3.85% 3.60% 3.0% n/a n/a n/a 3.05% 3.70% n/a 5.5% 4.0% 2040 3.70% 3.50% n/a 6.7% 4.0% 2040 Assumptions (in number of years) relating to future mortality, to determine the defined benefit obligation and the net benefit cost for the defined benefit pension plans are as follows: As at December 31 Males aged 65 at measurement date Females aged 65 at measurement date Males aged 40 at measurement date Females aged 40 at measurement date 2019 21.97 24.66 23.83 26.34 2018 21.89 24.59 23.76 26.28 Empire Life - Annual Report 2019 72 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The following table provides the sensitivity of the defined benefit pension and other post-employment benefit obligations to changes in significant actuarial assumptions. For each sensitivity test, the impact of a reasonably possible change in a single factor is shown with other assumptions left unchanged. In practice, this is unlikely to occur, and changes in some of the assumptions may be correlated. When calculating the sensitivity of the defined benefit obligation to significant actuarial assumptions the same method has been applied as when calculating the Post-employment benefit liability recognized within the Consolidated Statements of Financial Position. As at December 31, 2019 Discount rate Rate of compensation increase Health care cost increase Life expectancy As at December 31, 2018 Discount rate Rate of compensation increase Health care cost increase Life expectancy Impact on Pension Benefit Obligation Impact on Other Post Employment Benefit Obligations Change in assumption Increase Decrease Increase Decrease 1% $ 1% $ 1% (32,260) $ 42,785 $ 12,660 $ (11,262) n/a n/a $ 1 year $ 6,685 $ (6,887) $ (838) $ n/a 965 $ 410 $ 1,003 n/a (817) (398) Impact on pension benefits Impact on other post employment benefits Change in assumption Increase Decrease Increase Decrease 1% $ 1% $ 1% (26,633) $ 10,509 $ n/a 36,824 $ (9,074) n/a $ 1 year $ 5,403 $ (5,397) $ (791) $ n/a 885 $ 400 $ 944 n/a (754) (390) The weighted average duration, in number of years, of the defined benefit obligations are: As at December 31 Staff pension plan Supplemental employee retirement plan Other post-employment benefits 2019 2018 15 12 11 14 13 11 Risks Through its defined benefit pension plan and the other post-employment benefit plan, the Company is exposed to a number of risks, the most significant of which are detailed below: Asset volatility The Plan obligations are calculated using a discount rate set with reference to corporate bond yields; if Plan assets underperform this yield, this will create a deficit. The pension plan holds a significant proportion of equities, which are expected to outperform corporate bonds in the long-term while producing volatility and risk in the short-term. Changes in bond yields A decrease in corporate bond yields will increase Plan obligations, although this will be partially offset by an increase in the value of the Plans’ bond holdings. Empire Life - Annual Report 2019 73 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Life expectancy The majority of the Plans’ obligations are to provide benefits for the life of the member, so increases in life expectancy will result in an increase in the Plans’ liabilities. In case of the funded plans, the Pension Committee ensures that the investment positions are managed in accordance with the investment philosophy outlined in the investment policy approved by the Human Resources Committee of the Board. The fundamental philosophy is to achieve acceptably high investment return over the long term without jeopardizing the level of security of the members’ benefits and without introducing too much volatility into the Company’s future expense. The Company's objective is to match assets to the pension obligations by investing in equities as well as fixed interest securities. The Company monitors how the duration and the expected yield of the investments are matching the expected cash outflows arising from the pension obligations. The Plan has not changed the processes used to manage its risks from previous periods. Investments are well diversified, such that the failure of any single investment would not have a material impact on the overall level of assets. The Plan invests primarily in Canadian Bonds and Equities through its' ownership of units in Empire Life segregated and mutual funds. The Company believes that equities offer the best returns over the long term with an acceptable level of risk. The last triennial valuation on the Staff Pension Plan was completed in November 2018, as at December 31, 2017. The next triennial valuation will be completed in 2021, as at December 31, 2020. 13. Subordinated Debt The table below presents the obligations included in Subordinated debt as at December 31. As at December 31 Series 2016-1(1) Series 2017-1(2) Total Subordinated Debt Fair Value Interest rate Earliest par call or redemption Date 3.383% December 16, 2021 3.664% March 15, 2023 2019 2018 Maturity Carrying value Carrying value 2026 2028 $ $ 199,639 199,459 399,098 $ 410,142 $ 199,463 199,304 398,767 400,820 (1) Series 2016-1 Subordinated 3.383% Unsecured Debentures due 2026. From December 16, 2021, interest is payable at 1.95% over the 3- month Canadian Deposit Offering Rate (CDOR). (2) Series 2017-1 Subordinated 3.664% Unsecured Debentures due 2028. From March 15, 2023, interest is payable at 1.53% over CDOR. 14. Insurance Premiums For the year ended December 31 2019 Gross Reinsurance ceded Net Gross 2018 Reinsurance ceded Life premiums Health premiums Total life and health premiums Annuity premiums $ 525,273 $ (120,236) $ 405,037 $ 502,456 $ (110,326) $ 407,262 932,535 159,293 (61,573) (181,809) (178) 345,689 750,726 159,115 363,144 865,600 155,040 (36,529) (146,855) (180) Total insurance premiums $ 1,091,828 $ (181,987) $ 909,841 $ 1,020,640 $ (147,035) $ Net 392,130 326,615 718,745 154,860 873,605 Empire Life - Annual Report 2019 74 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 15. Fee Income For the year ended December 31 Investment management, policyholder administration and guarantee fees Surrender charges and other miscellaneous fees Fee income 16. Benefits and Expenses (a) Insurance contract benefits and claims paid For the year ended December 31 2019 2019 249,714 $ 12,031 261,745 $ 2018 253,990 9,951 263,941 $ $ Gross Reinsurance ceded Net Gross 2018 Reinsurance ceded Life claims Health claims Total life and health claims Annuity benefits $ 231,237 $ (67,615) $ 163,622 $ 243,402 $ (82,585) $ 279,398 510,635 209,681 (31,146) (98,761) (3,294) 248,252 411,874 206,387 240,346 483,748 186,508 (16,505) (99,090) (1,406) Benefits and claims paid $ 720,316 $ (102,055) $ 618,261 $ 670,256 $ (100,496) $ (b) Change in insurance contract liabilities and reinsurance ceded For the year ended December 31 2019 Gross Reinsurance ceded Net Gross 2018 Reinsurance ceded Life Health Total life and health Annuity $ 811,912 $ (73,845) $ 738,067 $ (194,523) $ 147,164 $ 70,437 882,349 15,096 (18,398) (92,243) 1,814 52,039 790,106 16,910 22,188 (172,335) (16,107) (8,392) 138,772 (772) Change in insurance contract liabilities $ 897,445 $ (90,429) $ 807,016 $ (188,442) $ 138,000 $ 17. Operating Expenses Operating expenses include the following: For the year ended December 31 Salary and benefits expense Professional services Rent, maintenance and amortization of right-of-use assets Amortization of property and equipment and intangibles Other Total $ $ 2019 102,869 $ 16,922 15,281 9,975 27,423 172,470 $ 164,656 Significant components of other expenses include travel, advertising, and office supplies and services. Empire Life - Annual Report 2019 75 Net 160,817 223,841 384,658 185,102 569,760 Net (47,359) 13,796 (33,563) (16,879) (50,442) 2018 98,444 16,888 12,624 9,461 27,239 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 18. Income Taxes (a) Income tax expense The Company’s income tax expense includes provisions for current and deferred taxes as follows: For the year ended December 31 Current income tax expense Deferred income tax expense (benefit) Relating to the origination and reversal of temporary differences Income tax expense 2019 59,644 $ (1,147) 58,497 $ $ $ During 2019 the Company paid income tax installments totaling $28,729 (2018 $54,590). (b) Variance from statutory provision Income taxes provided varies from the expected statutory provision as follows: For the year ended December 31 Net income before income taxes Income tax provision at statutory rates Increase (decrease) resulting from: Tax paid on dividends Miscellaneous Income tax expense 2019 249,156 $ 66,450 (10,360) 2,407 58,497 $ $ $ 2018 38,870 (1,806) 37,064 2018 184,953 49,474 (10,152) (2,258) 37,064 The current enacted corporate tax rates as they impact the Company in 2019 stand at 26.67% (2018 26.75%). Expected future tax rates are as follows: 2020 2021 2022 2023 2024 26.53% 26.46% 26.38% 26.38% 26.38% The impact of future enacted corporate tax rates has been taken into consideration in the deferred tax calculation. (c) Deferred income taxes In certain instances the tax basis of assets and liabilities differs from the carrying amount. These differences will give rise to deferred income taxes, which are reflected on the Consolidated Statements of Financial Position. These differences arise in the following items: As at December 31 Insurance contracts Portfolio investments Post-employment benefit plans Other, net Deferred income tax asset (liability) 2019 (10,882) $ (6,009) 11,169 (3,083) 2018 (9,867) (5,527) 9,957 (4,851) (8,805) $ (10,288) $ $ Of the above total, $7,222 is expected to be paid (2018 $8,002 paid) more than one year after the Consolidated Statements of Financial Position date. Empire Life - Annual Report 2019 76 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The net movement on the deferred income tax account is as follows: For the year ended December 31 Deferred income tax asset (liability) - beginning of year Deferred income tax benefit (expense) Statement of operations Other comprehensive income Deferred income tax asset (liability) - end of year 2019 2018 (10,288) $ (13,766) 1,147 336 1,806 1,672 (8,805) $ (10,288) $ $ (d) Income taxes included in other comprehensive income Other comprehensive income (loss) is presented net of income taxes. The following income tax amounts are included in each component of total OCI. For the year ended December 31 2019 Before tax Tax provision (recovery) After tax Before tax 2018 Tax provision (recovery) After tax Unrealized fair value change on available for sale investments Fair value change on available for sale investments reclassified to net income, including impairment write downs Remeasurements of post-employment benefit liabilities $ 89,474 $ 23,862 $ 65,612 $ (38,651) $ (10,339) $ (28,312) (21,886) (5,884) (16,002) 1,411 762 649 (1,260) (336) (924) (6,267) (1,672) (4,595) Total other comprehensive income (loss) $ 66,328 $ 17,642 $ 48,686 $ (43,507) $ (11,249) $ (32,258) The following income tax amounts are included in each component of shareholders’ OCI: For the year ended December 31 2019 Before tax Tax provision (recovery) After tax Before tax 2018 Tax provision (recovery) After tax Unrealized fair value change on available for sale investments Fair value change on available for sale investments reclassified to net income, including impairment write downs Remeasurements of post-employment benefit liabilities Shareholder portion of policyholder other comprehensive income (loss) $ 83,481 $ 22,264 $ 61,217 $ (33,305) $ (8,909) $ (24,396) (16,920) (4,520) (12,400) 1,728 871 857 (1,205) (321) (884) (5,973) (1,593) (4,380) 30 7 23 (458) (125) (333) Total other comprehensive income (loss) $ 65,386 $ 17,430 $ 47,956 $ (38,008) $ (9,756) $ (28,252) The following income tax amounts are included in each component of policyholders’ OCI: For the year ended December 31 2019 Before tax Tax provision (recovery) After tax Before tax 2018 Tax provision (recovery) After tax Unrealized fair value change on available for sale investments Fair value change on available for sale investments reclassified to net income, including impairment write downs Remeasurements of post-employment benefit liabilities Shareholder portion of policyholder other comprehensive income (loss) (Note 23) $ 5,993 $ 1,598 $ 4,395 $ (5,346) $ (1,430) $ (3,916) (4,966) (1,364) (3,602) (55) (30) (15) (7) (40) (23) (317) (294) 458 (109) (79) 125 (208) (215) 333 Total other comprehensive income (loss) $ 942 $ 212 $ 730 $ (5,499) $ (1,493) $ (4,006) Empire Life - Annual Report 2019 77 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 19. Earnings Per Share Earnings per share is calculated by dividing common shareholders' net income by the weighted average number of common shares outstanding. The preferred shares issued (refer to Note 20) do not dilute EPS as the preferred shares are not convertible into common shares. Details of the calculation of the net income and the weighted average number of shares used in the EPS computations are as follows: For the year ended December 31 Basic and diluted EPS Common shareholders' net income Weighted average number of common shares outstanding Basic and diluted EPS 20. Capital Stock 2019 2018 $ $ 173,943 $ 985,076 176.58 $ 137,445 985,076 139.53 As at December 31, 2019 December 31, 2018 Shares authorized Shares issued and outstanding Amount Shares authorized Shares issued and outstanding Amount Preferred shares Series 1 Series 3 Common shares unlimited unlimited 2,000,000 5,980,000 $ 4,000,000 $ 149,500 100,000 unlimited unlimited 5,980,000 $ 4,000,000 $ 149,500 100,000 985,076 $ 985 2,000,000 985,076 $ 985 In the fourth quarter of 2017, Empire Life issued to E-L Financial Corporation Limited 4,000,000 Non-Cumulative Rate Reset Preferred Shares, Series 3 (Series 3 Preferred Shares) at $25 per share. Holders of Series 3 Preferred Shares are entitled to receive fixed non-cumulative quarterly dividends yielding 4.90% annually, as and when declared by the Board of Directors of Empire Life, for the initial period ending on and including January 17, 2023. Thereafter, the dividend rate will be reset every five years at a rate equal to the 5-year Government of Canada bond yield plus 3.24%. Holders of Series 3 Preferred Shares will have the right, at their option, to convert their shares into Non-Cumulative Floating Rate Preferred Shares, Series 4 (Series 4 Preferred Shares), subject to certain conditions, on January 17, 2023 and on January 17 every five years thereafter. Holders of the Series 4 Preferred Shares will be entitled to receive non-cumulative quarterly floating dividends, as and when declared by the Board of Directors of Empire Life, at a rate equal to the three-month Government of Canada Treasury Bill yield plus 3.24%. In the first quarter of 2016, Empire Life issued to the public 5,980,000 Non-Cumulative Rate Reset Preferred Shares, Series 1 (Series 1 Preferred Shares) at $25 per share. Holders of Series 1 Preferred Shares are entitled to receive fixed non-cumulative quarterly dividends yielding 5.75% annually, as and when declared by the Board of Directors of Empire Life, for the initial period ending on and including April 17, 2021. Thereafter, the dividend rate will be reset every five years at a rate equal to the 5-year Government of Canada bond yield plus 4.99%. Holders of Series 1 Preferred Shares will have the right, at their option, to convert their shares into Non- Cumulative Floating Rate Preferred Shares, Series 2 (Series 2 Preferred Shares), subject to certain conditions, on April 17, 2021 and on April 17 every five years thereafter. Holders of the Series 2 Preferred Shares will be entitled to receive non-cumulative quarterly floating dividends, as and when declared by the Board of Directors of Empire Life, at a rate equal to the three-month Government of Canada Treasury Bill yield plus 4.99%. The cost of issuance of the Series 1 Preferred Shares, $5,150 less $1,375 of income tax, was charged to retained earnings. Empire Life - Annual Report 2019 78 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 21. Dividends Common shareholder dividends Common shares Preferred shareholder dividends Series 1 Series 3 Dividend declaration date Shares issued and outstanding Dividend rate per share Total dividend ($ 000's) Dividend payment date October 30, 2019 August 1, 2019 May 2, 2019 February 27, 2019 October 31, 2018 August 3, 2018 May 3, 2018 February 27, 2018 October 30, 2019 August 1, 2019 May 2, 2019 February 27, 2019 October 31, 2018 August 3, 2018 May 3, 2018 February 27, 2018 October 30, 2019 August 1, 2019 May 2, 2019 February 27, 2019 October 31, 2018 August 3, 2018 May 3, 2018 February 27, 2018 985,076 985,076 985,076 985,076 985,076 985,076 985,076 985,076 5,980,000 5,980,000 5,980,000 5,980,000 5,980,000 5,980,000 5,980,000 5,980,000 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 4,000,000 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 17.440800 17.440800 17.440800 17.440800 10.151501 10.151501 10.151501 10.151501 0.359375 0.359375 0.359375 0.359375 0.359375 0.359375 0.359375 0.359375 0.306250 0.306250 0.306250 0.306250 0.306250 0.306250 0.306250 0.306250 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 17,181 December 10, 2019 17,180 September 12, 2019 17,181 June 11, 2019 17,180 April 4, 2019 10,000 December 5, 2018 10,000 September 12, 2018 10,000 June 8, 2018 10,000 April 3, 2018 2,149 January 17, 2020 2,149 October 17, 2019 2,149 July 17, 2019 2,149 April 17, 2019 2,149 January 17, 2019 2,149 October 17, 2018 2,149 July 17, 2018 2,149 April 17, 2018 1,225 January 17, 2020 1,225 October 17, 2019 1,225 July 17, 2019 1,225 April 17, 2019 1,225 January 17, 2019 1,225 October 17, 2018 1,225 July 17, 2018 1,225 April 17, 2018 On February 26, 2020, subsequent to the date of these Consolidated Financial Statements, the Board approved the following cash dividends: • • • $111,743 ($113.435853 per share) on the issued and outstanding Common Shares, payable on April 8, 2020. $2,149 ($0.359375 per share) on the issued and outstanding Series 1 Preferred Shares, payable on April 17, 2020. $1,225 ($0.306250 per share) on the issued and outstanding Series 3 Preferred Shares, payable on April 17, 2020. 22. Shareholders' Equity Entitlement Shareholders’ entitlement to $3,369 (2018 $3,137) of shareholders’ equity is contingent upon future payment of dividends to participating policyholders. Empire Life - Annual Report 2019 79 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 23. Segmented Information The Company operates in the Canadian life insurance industry and follows a product line management approach for internal reporting and decision making. A description of the product lines is as follows: The Wealth Management product line includes segregated funds, mutual funds, guaranteed interest rate annuities and annuities providing income for life. The Employee Benefits product line offers group benefit plans to employers for medical, dental, disability, and life insurance coverage of their employees. The Individual Insurance product line includes both non-participating and participating individual life and health insurance products. Capital and Surplus is made up of assets held in the shareholders’ and participating policyholders’ equity accounts and other corporate items not allocated to other segments. Operating results are segmented into three product lines along with the Company’s capital and surplus as follows: Net premiums from external customers $ 159,115 $ 360,383 $ 390,343 $ — $ For the year ended December 31, 2019 Wealth Management Employee Benefits Individual Insurance Capital & Surplus Total 909,841 276,364 325,717 490,381 183,162 215,123 473,402 56,555 66,418 (5,106) 110,575 (6,572) 105,331 502 228 156,018 772,537 — 31,438 5,120 59,233 74,951 — 10,566 3,770 16,192 65,468 21,198 (29) — — — — 1,553 — 14,425 — — 15,882 44,049 21,886 261,745 618,261 807,016 937 31,438 9,975 172,470 198,754 14,425 18,675 3,770 58,497 190,658 Interest income Total investment income Fair value change in fair value through profit or loss assets Realized gain (loss) on fair value through profit or loss assets Realized gain (loss) on available for sale assets including impairment write downs Fee income from external customers Net benefits and claims Net change in insurance contract liabilities Change in investment contract provision Policy dividends Amortization of property and equipment and intangibles Total operating expenses Net commission expense Interest expense Premium tax Investment and capital tax Income tax expense (recovery) Net income (loss) after tax 30,202 39,656 17,772 1,147 101 249,018 206,387 16,910 937 — 1,965 61,333 83,162 — — — 23,898 74,182 6,445 4,520 4,313 181 85 12,528 255,856 17,569 — — 2,890 50,351 40,641 — 8,109 — 2,525 6,959 Empire Life - Annual Report 2019 80 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Net premiums from external customers $ 154,860 $ 339,852 $ 378,893 $ — $ For the year ended December 31, 2018 Wealth Management Employee Benefits Individual Insurance Capital & Surplus Interest income Total investment income Fair value change in fair value through profit or loss assets Realized gain (loss) on fair value through profit or loss assets Realized gain (loss) on available for sale assets including impairment write downs Fee income from external customers Net benefits and claims Net change in insurance contract liabilities Change in investment contract provision Policy dividends Amortization of property and equipment and intangibles Total operating expenses Net commission expense Interest expense Premium tax Investment and capital tax Income tax expense (recovery) Net income (loss) after tax 31,166 38,776 (35,073) 816 227 252,878 185,102 (16,880) 85 — 1,930 59,368 87,936 — — — 23,594 73,279 Total 873,605 261,218 308,428 (318,039) 5,870 4,059 168,194 199,215 (964) (279,132) 55,988 66,378 (2,870) 9 206 10,613 230,428 727 — — 2,138 45,595 36,328 — 8,354 — 8,483 23,860 14,635 (3,560) 11,900 48 388 154,230 (34,289) — 30,124 5,393 58,248 73,933 — 10,683 3,922 (2,119) 19,315 (1,892) 62 — — — — — 1,445 — 18,132 — — 7,106 31,435 (1,411) 263,941 569,760 (50,442) 85 30,124 9,461 164,656 198,197 18,132 19,037 3,922 37,064 147,889 Assets are segmented into three product lines along with the Company’s capital and surplus as follows: Assets excluding segregated funds Segregated funds Total assets Assets excluding segregated funds Segregated funds Total assets For the year ended December 31, 2019 Wealth Management Employee Benefits Individual Insurance Capital & Surplus Total 958,480 $ 171,166 $ 5,982,511 $ 2,350,049 $ 9,462,206 8,480,294 — 18,289 — 8,498,583 9,438,774 $ 171,166 $ 6,000,800 $ 2,350,049 $ 17,960,789 For the year ended December 31, 2018 Wealth Management Employee Benefits Individual Insurance Capital & Surplus Total 944,448 $ 153,194 $ 5,057,860 $ 2,291,405 $ 8,446,907 7,805,676 — 17,114 — 7,822,790 8,750,124 $ 153,194 $ 5,074,974 $ 2,291,405 $ 16,269,697 $ $ $ $ While specific general fund assets are nominally matched against specific types of general fund liabilities or held in the shareholders’ and policyholders’ equity accounts, all general fund assets are available to pay all general fund liabilities, if required. Segregated fund assets are not available to pay liabilities of the general fund. Empire Life - Annual Report 2019 81 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 24. Commitments and Contingencies Investment Commitments In the normal course of business, outstanding investment commitments are not reflected in the Consolidated Financial Statements. There was $22,867 (December 31, 2018, $13,000) of outstanding commitments as at December 31, 2019. The outstanding commitment is payable at any time up to and including April 30, 2021. Other contingencies The Company operates in the insurance industry and is subject to legal proceedings in the normal course of business. While it is not practicable to forecast or determine the final results of all pending or threatened legal proceedings, management does not believe that such proceedings (including litigation) will have a material effect on its results and financial position. The Company by-laws provide indemnification to its current and former directors, officers and employees to the extent permitted by law, against contractual indemnities and liabilities arising from their service to the Company. The broad general nature of these indemnification by-laws does not permit a reasonable estimate of the maximum potential amount of any liability. In certain cases, the Company would have recourse against third parties with respect to the foregoing items and the Company also maintains insurance policies that may provide coverage against certain of these items. 25. Related Party Transactions The Company is a 98.4% owned subsidiary of E-L Financial Services Limited (ELFS) which in turn is a 100.0% owned subsidiary of E-L Financial Corporation Limited (E-L). E-L owns, directly and indirectly through ELFS, 99.4% of the common shares of Empire Life. The Company’s ultimate controlling party is The Honourable Henry N. R. Jackman together with a trust created in 1969 by his father, Henry R. Jackman. In the normal course of business, the Company enters into transactions with E-L and other companies under common control or common influence involving the leasing of office property, investment management services and miscellaneous office services. The amounts earned and expensed were not significant. Some directors and officers have insurance and investment policies underwritten by the Company. In the fourth quarter of 2017, the Company issued 4,000,000 Non-Cumulative Rate Reset Preferred Shares, Series 3 to E-L Financial Corporation Limited at $25 per share. Refer to Note 20 for further details. Compensation of key management personnel Key management personnel are comprised of directors and executive officers of the Company. The remuneration of key management personnel is as follows: For the year ended December 31 Salaries and other short-term and long-term employee benefits Post-employment benefits Total $ $ 2019 6,140 $ 398 6,538 $ 2018 6,866 535 7,401 Post-employment benefits are comprised of employer current service costs for pension and other post- employment benefits. Empire Life - Annual Report 2019 82 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 26. Capital Management The Company aims to manage its regulatory capital in order to meet the regulatory capital adequacy requirements of the Insurance Companies Act (Canada) as established and monitored by OSFI. Effective January 1, 2018, OSFI has implemented the new Life Insurance Capital Adequacy Test (LICAT) framework. Under this framework, the Company’s capital adequacy will be measured as a ratio of Available Capital plus Surplus Allowance and Eligible Deposits divided by a Base Solvency Buffer. The components of the LICAT ratio are determined in accordance with the guidelines defined by OSFI. The regulator has established a Supervisory Target Total Ratio of 100% and a Supervisory Target Core Ratio of 70%. As at December 31, 2019 and December 31, 2018 the Company was in compliance with the applicable regulatory capital ratios. Empire Life - Annual Report 2019 83 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) 27. Risk Management The Company is exposed to risks arising from its investing activities and its insurance operations and to general reputation risk associated with these activities and its ability to manage specific risks. The following sections describe the principal risks and associated risk management strategies for the risks that management considers to be most significant in terms of likelihood and the potential adverse impact on the Company: market, liquidity, credit and insurance. Caution related to sensitivities In the sections that follow, the Company provides sensitivities and risk exposure measures for certain risks. These include sensitivities due to specific changes in market prices and interest rates, based on the market prices, interest rates, assets, liabilities and business mix in place as at the calculation dates. The sensitivities are calculated independently for each risk factor, assuming that all other risk variables remain constant. Actual results can differ materially from these estimates for a variety of reasons, including the interaction among these factors when more than one factor changes; changes in actuarial and investment return and future investment activity assumptions; actual experience differing from the assumptions; changes in business mix, effective tax rates and other market factors; and the general limitations of the Company’s internal models used for purposes of these calculations. Changes due to new sales or maturities, asset purchases/sales, or other management actions could also result in material changes to these reported sensitivities. For these reasons, the sensitivities should only be viewed as directional estimates of the underlying sensitivities for the respective factors based on the assumptions outlined, and should not be viewed as predictors for the Company’s future Net income, OCI, and capital sensitivities. Given the nature of these calculations, the Company cannot provide assurance that actual impact will be consistent with the estimates provided. Changes in risk variables in excess of the ranges illustrated may result in other than proportionate impacts. (a) Market risk Market risk is the risk of loss arising from adverse changes in market rates and prices such as interest rates, trading prices of equities, real estate and other securities, credit spreads and foreign exchange rates. Market risk is directly influenced by the volatility and liquidity in the markets in which the related financial instruments are traded, expectations of future price and yield movements and the composition of the Company’s investment portfolio. Under the Canadian insurance accounting and regulatory regime the Company’s results for any period reflect equity market values and interest rates at the end of the period through mark-to-market accounting. Consequently, a decline in public equity market values or changes in interest rates or spreads could result in material changes to net income attributed to shareholders, increases to regulatory capital requirements and reduction in the Company’s capital ratios. The Company buys investment quality bonds to support, to a very large extent, the liabilities under the insurance and annuity policies of the Company. The Company’s investment strategy also includes the use of publicly-listed common stocks or exchange-traded funds (ETFs) to support the liabilities under its insurance policies. Cash flows arising from these investments are intended to match the liquidity requirements of the Company’s policies, within the limits prescribed by the Company. However, if the Company does not achieve the expected returns underlying the pricing of its products, its operating results may be adversely affected. Furthermore, a decrease in the fair value of the Company's common stock portfolio results in reduced shareholders’ equity, reduced policyholders’ surplus and a reduced LICAT position. Regulatory pressure to increase capital escalates as the LICAT position approaches OSFI’s supervisory minimum. Net income would also be reduced if the declines in value are realized through dispositions or recognized in provisions for impairment. The Company manages this risk exposure mainly through investment limits and oversight of its investment managers by the Chief Investment Officer, the Asset Management Committee, and the Investment Committee of the Board. The Investment Committee actively monitors the portfolio size and asset mix. Empire Life - Annual Report 2019 84 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The Company’s general fund investments are subject to limits established by the Insurance Companies Act and to investment guidelines established by the Investment Committee of the Board. The investment guidelines are designed to limit overall investment risk by defining investment objectives, eligible investments, diversification criteria, exposure, concentration and asset quality limits for eligible investments by segment. The Investment Committee receives reporting on general fund asset mix and performance by segment, derivatives matching, segregated fund asset mix and performance, and investment transactions for all funds. In addition, on at least a quarterly basis, management and the Company’s investment managers report to the Investment Committee, and through the Investment Committee to the Board, on portfolio content, asset mix, the Company’s matched position, the performance of general and segregated funds and compliance with the investment guidelines. The Company has an Asset Management Committee, which meets regularly and reports at least quarterly to the Investment Committee of the Board. The mandate of the Asset Management Committee includes monitoring of the matched position of Empire’s investments in relation to its liabilities within the various segments of the Company’s operations. The matching process is designed to require that assets supporting policy liabilities closely match the timing and amount of policy obligations, and to plan for the appropriate amount of liquidity in order to meet its financial obligations as they fall due. Investments and asset/liability management guidelines, which are reviewed regularly with the Investment Committee, have been established to govern these activities. The Asset Management Committee reports regularly to the Investment Committee on the Company’s matched positions, asset mixes, and investment allocation decisions relative to the Company’s asset segments. The Company has established a Capital Management Policy, capital management levels that exceed regulatory minimums and Dynamic Capital Adequacy Testing (DCAT) that takes into account the potential effect of adverse investment-risk scenarios (including adverse market conditions and adverse interest rates) on the Company’s capital position and liquidity. Management monitors its LICAT position on a regular basis and reports at least quarterly to the Board on the Company’s LICAT. For the Company, the most significant market risks are equity risk, interest rate risk and foreign exchange rate risk. (1) Equity risk The Company’s investment portfolio consists primarily of bonds and equity securities and the fair value of its investments varies according to changes in general economic and securities market conditions, including volatility and declines in equity markets. Equity market volatility could occur as a result of general market volatility or as a result of specific social, political or economic events. A decline in securities markets could have an adverse impact on the return on assets backing capital, capital adequacy, and the management fees collected on segregated fund contracts, mutual funds and on index funds within universal life contracts and insurance policy liabilities and capital requirements, particularly in respect of segregated fund guarantees. The risk of fluctuation of the market value of the Company’s segregated funds and mutual funds is generally assumed by the policyholders and unit holders, respectively. Market value variations of such assets will result in variations in the income of the Company to the extent fees are determined in relation to the value of such funds. A significant and steady decline of the securities markets may result in net losses on such products which could adversely affect the Company. Additionally, certain of the Company’s segregated fund products contain guarantees upon death, maturity or withdrawal, where the guarantee may be triggered by the market performance of the underlying funds. If a significant market decline is experienced, the resulting increased cost of providing these guarantees could have an adverse effect on the Company’s financial position, LICAT position and results of operations. The Company has reinsured a portion of its segregated fund death benefit guarantee. The Company also has a semi-static, economic hedging program. The objective of the economic hedging program is to partially protect the Company from possible future LICAT ratio declines that might result from adverse stock market price changes. The program presently employs put options and futures on key equity indices. Improper use of these Empire Life - Annual Report 2019 85 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) instruments could have an adverse impact on earnings. The Company manages this risk by applying limits established by the Investment Committee in its investment guidelines, which set out permitted derivatives and permitted uses for derivatives, as well as limits to the use of these instruments. In particular, no leverage is permitted in the use of derivatives and strict counterparty credit restrictions are imposed. The Company has an Equity Risk Hedging Policy to support general fund economic hedging programs. The policy outlines objectives, risk limits and authorities associated with its economic hedging activities. Management monitors its economic hedging activities on a regular basis and reports, at least quarterly, to the Risk and Capital Committee of the Board on the status of the economic hedging program. The Company uses stochastic models to monitor and manage risk associated with segregated fund guarantees and establishes policyholder liability provisions in accordance with standards set forth by the CIA. Product development and pricing policies also require consideration of portfolio risk and capital requirements in the design, development and pricing of the products. The Chief Risk Officer reports quarterly to the Risk and Capital Committee of the Board on the nature and value of the Company’s segregated fund guarantee liabilities, including capital requirements. The following table summarizes the estimated potential impact on the Company of a change in global equity markets. The Company uses a 10% increase or decrease in equity markets as a reasonably possible change in equity markets. The Company has also disclosed the impact of a 20% increase or decrease in its equity market sensitivity. The amounts in the following table include the effect of Empire Life’s general fund equity risk economic hedging program (described above). For segregated fund guarantees the level of sensitivity is highly dependent on the level of the stock market at the time of performing the estimate. If period end equity markets are high relative to market levels at the time that segregated fund policies were issued, the sensitivity is reduced. If period end equity markets are low relative to market levels at the time that segregated fund policies were issued, the sensitivity is increased. Shareholders' net income (including segregated fund guarantees)* $ 13,800 $ (17,521) $ 31,350 $ (80,143) Policyholders' net income Shareholders' other comprehensive income Policyholders' other comprehensive income $ nil $ nil $ nil $ nil $ 3,245 $ (3,245) $ 6,490 $ (6,490) $ nil $ nil $ nil $ nil As at December 31, 2019 10% Increase 10% Decrease 20% Increase 20% Decrease Shareholders' net income (including segregated fund guarantees)* $ 16,371 $ (15,902) $ 34,749 $ (149,572) Policyholders' net income Shareholders' other comprehensive income Policyholders' other comprehensive income $ nil $ nil $ nil $ nil $ $ 2,590 $ 1,257 $ (2,590) $ (1,257) $ 5,180 $ 2,514 $ (5,180) (2,514) As at December 31, 2018 10% Increase 10% Decrease 20% Increase 20% Decrease *Includes the estimated impact on fee income net of trailer commissions after tax for a three month period Empire Life - Annual Report 2019 86 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) For the life insurance business, the Company’s policy is to use equity investments to cover a portion of the estimated insurance liability cash flows of non-participating life and universal life products beyond 20 years following the balance sheet date. The value of the liabilities supported by these equity investments depends on assumptions about the future level of equity markets. The best-estimate return assumptions for equities are primarily based on long-term historical averages of total returns (including dividends) for the Canadian equity market, which is 9.0% (2018 8.8%). The Company uses an assumption of 7.7% (2018 8.0%) to include provisions for moderate changes in equity rates of return determined in accordance with Canadian actuarial standards of practice. The returns are then reduced by margins to determine the net returns used in the valuation. Changes in the current market would result in changes to these assumptions. The impact of an immediate change in equity markets is described above. If the change in equity markets persisted for one year, then a change to the actuarial future equity market return assumption would be made. For non-participating insurance business, a 1.0% decrease in future equity market returns would result in an increase to policy liabilities thereby reducing Net income by approximately $127,300 (2018 $110,500). The following table identifies the concentration of the Company's common equity holdings in Empire Life's investment portfolios: As at December 31 Holdings of common equities in the 10 issuers to which the Company had the greatest exposure Percentage of total cash and investments Exposure to the largest single issuer of common equities Percentage of total cash and investments (2) Interest rate risk $ $ 2019 2018 648,049 $ 352,369 7.0% 4.3% 444,366 $ 110,324 4.8% 1.3% Interest rate risk arises when economic losses are incurred due to the need to reinvest or divest during periods of changing interest rates. Changes in interest rates, as a result of the general market volatility or as a result of specific social, political or economic events, could have an adverse effect on the Company’s business and profitability in several ways. Certain of the Company’s product offerings contain guarantees and, if long-term interest rates fall below those guaranteed rates, the Company may be required to increase policy liabilities against losses, thereby adversely affecting its operating results. Interest rate changes can also cause compression of net spread between interest earned on investments and interest credited to customers, thereby adversely affecting the Company’s operating results. Rapid declines in interest rates may result in, among other things, increased asset calls and mortgage prepayments and require reinvestment at significantly lower yields, which could adversely affect earnings. Additionally, during periods of declining interest rates, bond redemptions generally increase, resulting in the reinvestment of such funds at lower current rates. Rapid increases in interest rates may result in, among other things, increased surrenders. Fluctuations in interest rates may cause losses to the Company due to the need to reinvest or divest during periods of changing interest rates, which may force the Company to sell investment assets at a loss. In addition, an interest rate sensitivity mismatch between assets and the liabilities that they are designated to support could have an adverse effect on the Company’s financial position and operating results. Empire Life - Annual Report 2019 87 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The following tables summarize the estimated immediate financial impact on Net income and OCI as a result of an immediate change in interest rates. Shareholders' net income Policyholders' net income Shareholders' other comprehensive income Policyholders' other comprehensive income Shareholders' net income Policyholders' net income Shareholders' other comprehensive income Policyholders' other comprehensive income $ $ $ $ $ $ $ $ As at December 31, 2019 50 bps Increase 50 bps Decrease 100 bps Increase 100 bps Decrease 20,751 $ (22,972) $ 39,524 $ (48,444) 233 $ (254) $ 446 $ (531) (45,776) $ (1,288) $ 54,420 $ (82,907) $ 117,484 1,422 $ (2,442) $ 2,979 As at December 31, 2018 50 bps Increase 50 bps Decrease 100 bps Increase 100 bps Decrease 8,361 $ 204 $ (39,075) $ (1,905) $ (9,248) $ (222) $ 15,932 $ (19,494) 391 $ 46,055 $ (71,171) $ 2,101 $ (3,614) $ (463) 99,089 4,399 The computation of policy liabilities takes into account projected investment income net of investment expenses from the assets supporting policy liabilities, and investment income expected to be earned on reinvestments. The assets supporting the policy liabilities are segmented from the assets backing shareholders’ and policyholders’ equity. For life and health insurance, the projected cash flows from the assets supporting policy liabilities are combined with estimated future reinvestment rates based on both the current economic outlook and the Company’s expected future asset mix. In order to provide a margin that recognizes the mismatch of assets and liabilities, the cash flows are subjected to tests under a wide spectrum of possible reinvestment scenarios, and the policy liabilities are then adjusted to provide for credible adverse future scenarios. In order to match the savings component of policy liabilities that vary with a variety of indices and currencies, the Company maintains certain equity, bond and currency financial instruments as part of its general fund assets. Asset-liability mismatch risk for these liabilities is monitored on a daily basis. For the life insurance business, where the insurance contract liabilities have a longer term than most available bonds and mortgages, the Company will need to reinvest net cash flows arising in the future to extend the duration of its assets. Under Canadian actuarial standards of practice, the yields assumed for these future reinvestments are related to current interest rates, the current economic outlook and the Company’s expected future asset mix. The reinvestment assumption grades from the initial reinvestment rate (IRR) assumption to the ultimate reinvestment rate (URR) assumption over the rolling 40-year period following the balance sheet date. The estimated impact of an immediate change in interest rates is described above. If interest rates increase or decrease during the next year, then a change to the IRR assumption would be required to take into account the then-current economic outlook. For non-participating insurance business, a 1.0% decrease in interest rates would cause a decrease in reinvestment assumption for the next 40-years, resulting in an increase to policy liabilities thereby reducing net income by approximately $52,500 (2018 $38,000). This assumes no change in the URR assumption. Empire Life - Annual Report 2019 88 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) For investment income expected to be earned on reinvestments beyond the rolling 40-year period, the Company uses an URR assumption. Under Canadian actuarial standards of practice, the URR assumption is prescribed as a long-term ultimate risk-free reinvestment rate of 3.1% (2018 3.2%) plus a maximum amount for credit spreads minus asset default rates of 0.8% (2018 0.8%). The prescribed level of the URR assumption may be periodically changed by the actuarial standards setting body. As interest rates are currently lower than they were when the current URR assumptions were set, there may be a downward bias if the rates were to be updated. In order to provide a margin that recognizes the longer-term mismatch, the cash flows are subjected to tests under a wide spectrum of possible reinvestment scenarios, and the insurance contract liabilities are then adjusted to provide for credible adverse future scenarios. The Company uses an URR of 3.9% (2018 4.0%) to adjust for credible adverse scenarios. For annuity business, where the timing and amount of the benefit obligations can be more readily determined, much closer matching of the asset and liability cash flows is possible which helps mitigate the potential impact on the business from a sudden increase or decrease in interest rates. For annuity business, the impact a 1.0% decrease in assumed IRR has on policy liabilities and subsequently on Net income is negligible as a result of the matching process described above. Interest rate risk in Empire Life's investment portfolio is managed through Investment Committee established limits and regular reporting by management to the Investment Committee and the Board. The Company’s investment guidelines establish investment objectives and eligible interest rate sensitive investments, as well as establish diversification criteria, exposure, concentration and asset quality limits for these investments. The Asset Management Committee oversees sensitivity to interest rates. The objective is to maximize investment yields while managing the default, liquidity and reinvestment risks at acceptable levels and within risk tolerances. Product development and pricing policies and practices also require consideration of interest rate risk in the design, development and pricing of the products. (3) Foreign exchange rate risk Foreign exchange rate risk arises when the fair value of cash flows of a financial instrument fluctuate due to changes in exchange rates. This can create an adverse effect on earnings and equity when measured in the Company’s functional currency. The Company’s primary foreign currency exposure arises from portfolio investments denominated in US dollars. A 10% fluctuation in the US dollar would have an impact of approximately $ nil (2018 $ nil) on shareholders' Net income, $ nil (2018 $ nil) on policyholder's Net income, $ nil (2018 $ nil) on shareholders’ OCI and $ nil (2018 $ nil) on policyholders’ OCI. The Company’s exposure to foreign currency risk in its financial liabilities is not material. The Company uses derivative instruments, including futures contracts and foreign currency forward contracts, to manage foreign exchange risks. Improper use of these instruments could have an adverse impact on earnings. The Company manages this risk by applying limits established by the Investment Committee in its investment guidelines, which set out permitted derivatives and permitted uses for derivatives, as well as limits to the use of these instruments. In particular, no leverage is permitted in the use of derivatives and strict counterparty credit restrictions are imposed. The Company has a Foreign Exchange Risk Management Policy which outlines objectives, risk limits and authority associated with any foreign exchange rate exposure. Oversight and management of this policy falls under the responsibility of the Asset Management Committee, which reports exposures and any breaches to the Risk and Capital Committee of the Board. Empire Life - Annual Report 2019 89 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) (b) Liquidity risk Liquidity risk is the risk that an entity will not be able to fund all cash outflow commitments or obligations as they fall due or that, in order to fund commitments, an entity may have to sell assets at depressed prices resulting in losses at time of sale. Cash outflows could be in the form of benefit payments to policyholders, expenses, asset purchases and interest on debt. The majority of the Company’s obligations relate to its policy liabilities, the duration of which varies by line of business and expectations relating to key policyholder actions or events (i.e. cash withdrawal, mortality, and morbidity). The remaining obligations of the Company relate to the subordinated debt (refer to Note 13 - Subordinated Debt) and to ongoing operating expenses as they fall due, which are expected to settle in a very short period of time. The Company’s liquidity risk management strategy is to ensure that there will be sufficient cash to meet all financial commitments and obligations as they become due. The Company’s liquidity risk management program is monitored by management and by the Board of the Company through regular reporting to the Investment Committee. The Company monitors its cash flow obligations and meets its liquidity needs by holding high quality marketable investments that may be easily sold, if necessary, and by maintaining a portion of investments in cash and short-term investments. The Company maintains a liquidity policy requiring an assessment of the Company’s liquidity risk and specific procedures so that liquidity needs are met. Compliance with the policy is monitored by the Asset Management Committee and exposures and breaches are reported to the Investment Committee of the Board. The Company’s current liquidity position as at December 31 is provided in a table in Note 10(e). Based on the Company’s historical cash flows and current financial performance, management believes that the cash flows from the Company’s operating activities will continue to provide sufficient liquidity for the Company to satisfy debt service obligations and to pay other expenses. The following table shows details of the expected maturity profile of the Company's undiscounted obligations with respect to its financial liabilities and estimated cash flows of policy liabilities. Subordinated debt that are not due at a single maturity date are included in the tables in the year of final maturity. Actual maturities could differ from contractual maturities because of the borrower’s right to call or extend prepay obligations, with or without prepayment penalties. Policy liability cash flows include estimates related to the timing and payment of death and disability claims, policy maturities, annuity payments, policyholder dividends, amounts on deposit, commission and premium taxes offset by contractual future premiums and fees on in-force business. Recoveries from reinsurance agreements are also reflected. Segregated fund liabilities are excluded from this analysis. These estimated cash flows are based on the best estimate assumptions, with margins for adverse deviations, used in the determination of policy liabilities. The actuarial and other policy liability amounts included in the Company's 2019 Consolidated Financial Statements are based on the present value of the estimated cash flows. Due to the use of assumptions, actual cash flows will differ from these estimates. Insurance contract liabilities Investment contract liabilities Subordinated debt Preferred shares Accounts payable and Other liabilities Total liabilities Operating lease commitments As at December 31, 2019 1 year or less 1 - 5 years 5 - 10 years Over 10 years Total $ 71,689 $ 162,523 $ 513,593 $ 23,596,531 $ 24,344,336 3,823 14,094 13,496 227,908 331,010 115 12,418 51,294 232,280 7,044 11,665 439,960 — 42,616 9,882 — — — 37,788 505,348 245,776 277,568 465,559 1,007,834 23,606,413 25,410,816 — — — 115 Total $ 331,125 $ 465,559 $ 1,007,834 $ 23,606,413 $ 25,410,931 Empire Life - Annual Report 2019 90 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Insurance contract liabilities Investment contract liabilities Subordinated debt Preferred shares Accounts payable and Other liabilities Total liabilities Operating lease commitments As at December 31, 2018 1 year or less 1 - 5 years 5 - 10 years Over 10 years Total $ 96,260 $ 189,647 $ 492,727 $ 23,285,372 $ 24,064,006 4,084 14,094 13,496 230,291 358,225 3,106 10,685 51,708 245,776 8,230 506,046 5,884 9,704 453,240 — 36,525 8,714 — — — 33,187 519,042 259,272 275,046 992,196 23,294,086 25,150,553 3,129 — 12,119 Total $ 361,331 $ 511,930 $ 995,325 $ 23,294,086 $ 25,162,672 The Asset Management Committee, which meets regularly, monitors the matched position of the Company’s investments in relation to its liabilities within the various segments of its operations. The matching process is designed to require that assets supporting policy liabilities closely match, to the extent possible, the timing and amount of policy obligations, and to plan for the appropriate amount of liquidity in order to meet its financial obligations as they fall due. The Company maintains a portion of its investments in cash, cash equivalents and short-term investments to meet its short-term funding requirements. As at December 31, 2019, 1.9% (2018 2.8%) of cash and investments were held in these shorter duration investments. (c) Credit risk Credit risk is the possibility of loss from amounts either owed by financial counterparties, such as debtors, reinsurers and other financial institutions, or in connection with issuers of securities held in an asset portfolio. The Company is subject to credit risk which arises from debtors or counterparties who are unable to meet their obligations under debt or derivative instruments. This credit risk is derived primarily from investments in bonds, debentures, preferred shares, cash and cash equivalents, mortgages and from reinsurers under reinsurance agreements. The Company manages this risk by applying its investment guidelines and product design and pricing risk management policy established by the Investment Committee and Risk and Capital Committee of the Board respectively. The investment guidelines establish minimum credit ratings for issuers of bonds, debentures and preferred share investments, and provide for concentration limits by issuer of such debt instruments. Management and Board committees review credit quality relative to investment purchases and also monitor the credit quality of invested assets over time. Management reports regularly to the Investment Committee of the Company’s Board on the credit risk to which the portfolio is exposed. The Reinsurance Risk Management Policy (along with supporting material in the Product Design and Pricing Risk Management Policy) establishes reinsurance objectives and limits, and requires ongoing evaluation of reinsurers for financial soundness. The Company enters into long-term reinsurance agreements only with reinsurance companies that have a credit rating of “A-” or better. Credit risk analysis includes the consideration of credit spreads. From an investment perspective, when buying credit the Company is guided by two principles; first that there is a high likelihood of return of principal and second that there is an acceptable return on investment. The Company looks to obtain a risk/reward balance that aligns with its objectives and risk philosophy. When determining insurance contract liabilities, credit spreads and changes in credit spreads are reflected in the interest rate assumption. Empire Life - Annual Report 2019 91 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The Company has the following assets that are exposed to credit risk: As at December 31 Cash and cash equivalents Short-term investments Bonds Preferred shares Derivative assets Mortgages Reinsurance Loans on policies Policy contract loans Accrued investment income Insurance receivables Trade accounts receivable Total 2019 $ 140,333 $ 32,384 7,509,652 474,029 2,930 169,827 113,107 55,363 66,520 35,401 48,728 13,180 2018 204,921 27,959 6,530,080 395,860 10,424 193,074 95,975 51,949 69,180 35,388 46,701 14,326 $ 8,661,454 $ 7,675,837 Mortgages, Loans on policies and Policy contract loans are fully or partially secured. The Company has made provision in its Consolidated Statements of Financial Position for credit losses. Provisions have been made partly through reduction in the value of the assets (see Note 3(b)) and partly through a provision in policy liabilities (see Note 10(c)). Concentration of credit risk (1) Bonds and debentures The concentration of the Company’s bond portfolio by investment grade is as follows: As at December 31 AAA AA A BBB (and lower ratings) Total 2019 2018 Fair value % of Fair value Fair value % of Fair value $ 348,815 1,167,357 4,831,528 1,161,952 5% $ 16% 64% 15% 281,470 628,471 4,561,261 1,058,878 $ 7,509,652 100% $ 6,530,080 4% 10% 70% 16% 100% Credit ratings are normally obtained from Standard & Poor's (S&P) and Dominion Bond Rating Service (DBRS). In the event of a split rating, the lower rating is used. Issues not rated by a recognized rating agency are rated internally by the Investment Department. The internal rating assessment is documented referencing suitable comparable investments rated by recognized rating agencies and/or methodologies used by recognized rating agencies. Provincial bonds represent the largest concentration in the bond portfolio, as follows: As at December 31 Provincial bond holdings Percentage of total bond holdings 2019 2018 $ 4,182,725 $ 3,599,325 55.7% 55.1% Empire Life - Annual Report 2019 92 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The following table profiles the bond portfolio by contractual maturity, using the earliest contractual maturity date: As at December 31 1 year or less 1 - 5 years 5 - 10 years Over 10 years Total 2019 2018 Fair value % of Fair value Fair value % of Fair value $ 75,119 769,237 700,976 5,964,320 1% $ 10% 9% 80% 87,560 810,260 743,107 4,889,153 $ 7,509,652 100% $ 6,530,080 1% 12% 11% 76% 100% The following table discloses the Company's holdings of fixed income securities in the 10 issuers (excluding the federal government) to which the Company had the greatest exposure, as well as exposure to the largest single issuer of corporate bonds. As at December 31 2019 2018 Holdings of fixed income securities* in the 10 issuers (excluding federal governments) to which the Company had the greatest exposure Percentage of total cash and investments Exposure to the largest single issuer of corporate bonds Percentage of total cash and investments *Fixed income securities includes bonds, debentures, preferred shares and short term investments. $ $ 4,744,433 $ 4,248,837 51.1% 51.3% 199,877 $ 181,684 2.2% 2.2% (2) Preferred shares The Company’s preferred share investments are all issued by Canadian companies, with 1% (2018 1%) rated as P1, 97% rated as P2 (2018 99%) and the remaining 2% (2018 nil %) rated as P3. (3) Mortgages Mortgages in the province of Ontario represent the largest concentration with $169,058 or 99% (2018 $193,074 or 100%) of the total mortgage portfolio. (d) Insurance risk The Company provides a broad range of life insurance, health insurance and wealth management products, employee benefit plans, and financial services that are concentrated by product line as follows: (millions of dollars) Wealth Management Employee Benefits Individual Insurance Capital & Surplus Total For the year ended December 31 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 Net premium income Fee and other income Total $ 159.1 $ 154.9 $ 360.4 $ 339.8 $ 390.3 $ 378.9 $ — $ — $ 909.8 $ 873.6 249.0 252.9 12.5 10.6 0.2 0.4 — — 261.7 263.9 $ 408.1 $ 407.8 $ 372.9 $ 350.4 $ 390.5 $ 379.3 $ — $ — $ 1,171.5 $ 1,137.5 Insurance risk is the risk that actual experience related to claims, benefit payments, expenses, cost of embedded product options and cost of guarantees associated with insurance risks, does not emerge as expected. The Company is exposed to various insurance risks as a result of the business it writes, including: mortality, policyholder behaviour (termination or lapse), expenses, morbidity, longevity, product design and pricing risk, underwriting and claims risk and reinsurance risk. The Company regularly evaluates its exposure to foreseeable risks through stress testing techniques including DCAT analysis. Empire Life - Annual Report 2019 93 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The principal risk the Company faces under insurance contracts is the risk that experience on claims, policy lapses and operating expenses will not emerge as expected. To the extent that emerging experience is more favourable than assumed in the valuation, income will emerge. If emerging experience is less favourable, losses will result. Therefore, the objective of the Company is to establish sufficient insurance liabilities to cover these obligations with reasonable certainty. The computation of insurance liabilities and related reinsurance recoverable requires “best estimate” assumptions covering the remaining life of the policies. Assumptions in use are based on past experience, current internal data, external market indices and benchmarks which reflect current observable market trends and other published information. These assumptions are made for mortality, morbidity, longevity, lapse, expenses, inflation and taxes. Due to the long-term risks and measurement uncertainties inherent in the life insurance business, a margin for adverse deviations from best estimates is calculated separately for each variable and included in policy liabilities. These margins are intended to allow for possible deterioration in experience and to provide greater confidence that policy liabilities are adequate to pay future benefits. The effect of these margins is to increase policy liabilities over the best estimate assumptions. The margins for adverse deviation used by the Company are within the target range established by the CIA. A correspondingly larger margin is included in the insurance contract liabilities if an assumption is susceptible to change or if there is more uncertainty about the best estimate assumption. Each margin is reviewed annually for continued appropriateness. Policy liability assumptions are reviewed and updated at least annually by the Company’s Appointed Actuary. The impact of changes in those assumptions is reflected in earnings in the year of the change. Details related to the changes in assumptions are also discussed with the Audit Committee of the Board. The methods for arriving at the most important of these assumptions are outlined below. Also included are measures of the Company’s estimated net income sensitivity to changes in best estimate assumptions in the non-participating insurance liabilities, based on a starting point and business mix as of December 31, 2019. For participating business it is assumed that changes will occur in policyholder dividend scales corresponding to changes in best estimate assumptions such that the net change in participating insurance contract liabilities is immaterial. (1) Mortality The Company carries out annual internal studies of its own mortality experience. The valuation mortality assumptions are based on a combination of this experience and recent CIA industry experience. An increase in the rate of mortality will lead to a larger number of claims (and claims could occur sooner than anticipated), which for life insurance, will increase expenditures and reduce profits for the shareholders. For non-participating insurance business, a 2.0% increase in the best estimate mortality assumption would increase policy liabilities thereby decreasing Net income by approximately $15,800 (2018 $12,300). For annuity business, lower mortality (or longevity) is financially adverse so a 2.0% decrease in the best estimate mortality assumption would increase policy liabilities thereby decreasing Net income by approximately $3,300 (2018 $4,100). (2) Policyholder behaviour (termination or lapse) Policy termination (lapse) and surrender assumptions are based on a combination of the Company’s own internal termination studies (conducted annually) and recent CIA industry experience. Separate policy termination assumptions are used for permanent cash-value business, for renewable term insurance, term insurance to age 100 and for universal life insurance. In setting policy termination rates for renewable term insurance, it is assumed that extra lapses will occur at each renewal point and that healthy policyholders are more likely to lapse at that time than those who have become uninsurable. Empire Life - Annual Report 2019 94 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) Acquisition costs may not be recovered fully if lapses in the early policy years exceed those in the actuarial assumptions. An increase in policy termination rates early in the life of the policy would tend to reduce profits for shareholders. An increase in policy termination rates later in the life of the policy would tend to increase profits for shareholders if the product is lapse supported (such as term insurance to age 100), but decrease shareholder profits for other types of policies. For non-participating insurance and annuity business a 10.0% adverse change in the lapse assumption would result in an increase to policy liabilities thereby decreasing Net income by approximately $152,300 (2018 $132,800). For products where fewer terminations would be financially adverse to the Company, the change is applied as a decrease to the lapse assumption. Alternatively, for products where more terminations would be financially adverse to the Company, the change is applied as an increase to the lapse assumption. (3) Expenses Policy liabilities provide for the future expense of administering policies in force, renewal commissions, general expenses and taxes. Expenses associated with policy acquisition and issue are specifically excluded. The future expense assumption is derived from internal cost studies and includes an assumption for inflation. An increase in the level of expenses would result in an increase in expenditure thereby reducing profits for the shareholders. For non-participating insurance business and annuity business combined, a 5% increase in the maintenance expense assumption would result in an increase to policy liabilities thereby reducing net income by approximately $6,300 (2018 $6,900). (4) Morbidity The Company carries out annual internal studies of its own morbidity experience where morbidity refers to both the rates of accident or sickness and the rates of recovery from the accident or sickness. The valuation assumptions are based on a combination of internal experience and recent CIA industry experience. For individual critical illness business, the incidence rates (or rates of accident or sickness) are the key assumption related to morbidity. An increase in incidence rates would result in an increase in the number of claims which increases expenditures and reduces shareholders’ profits. For group long-term disability business the termination rates (or rates of recovery) are the key assumption related to morbidity. A decrease in termination rates would result in disability claims persisting longer which increases expenditures. For non-participating insurance business where morbidity is a significant assumption, a 5% adverse change in the assumption would result in an increase to policy liabilities thereby reducing Net income by approximately $7,900 (2018 $6,700). (5) Product design and pricing risk The Company is subject to the risk of financial loss resulting from transacting insurance business where the costs and liabilities assumed in respect of a product exceed the expectations reflected in the pricing of the product. This risk may be due to an inadequate assessment of market needs, a poor estimate of the future experience of several factors, such as mortality, morbidity, lapse experience, future returns on investments, expenses and taxes, as well as the introduction of new products that could adversely impact the future behaviour of policyholders. Empire Life - Annual Report 2019 95 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) For certain types of contracts, all or part of this risk may be shared with or transferred to the policyholder through dividends and experience rating refunds or through the fact that the Company can adjust the premiums or future benefits if experience turns out to be different than expected. For other types of contracts, the Company assumes the entire risk and thus must carry out a full valuation of the commitments in this regard. The Company manages product design and pricing risk through a variety of enterprise-wide programs and controls. The key programs and controls are described as follows. The Company has established policy liabilities in accordance with standards set forth by the CIA. Experience studies (both Company-specific and industry level) are factored into ongoing valuation, renewal and new business processes so that policy liabilities, as well as product design and pricing, take into account emerging experience. The Company has established an active capital management process that includes a Capital Management Policy and capital management levels that exceed regulatory minimums. As prescribed by regulatory authorities, the Appointed Actuary conducts DCAT and reports annually to the Audit Committee on the Company’s financial condition, outlining the impact on capital levels should future experience be adverse. The Company has a Product Design and Pricing Risk Management Policy governing all of its major product lines. This policy, which is established by the Product Management Review Committee ("PMRC") and approved by the Risk and Capital Committee of the Board, defines the Company’s product design and pricing risk management philosophy. The policy sets principles for prudent out product design and pricing approval authorities, product concentration limits, and required product development monitoring processes and controls. (6) Underwriting and claims risk The Company is subject to the risk of financial loss resulting from the selection and underwriting of risks to be insured and from the adjudication and settlement of claims. Many of the Company’s individual insurance and group disability products provide benefits over the policyholder’s lifetime. Actual claims experience may differ from the mortality and morbidity assumptions used to calculate the related premiums. Catastrophic events such as earthquakes, acts of terrorism or an influenza pandemic in Canada could result in adverse claims experience. In addition to the risk management controls described above under Product Design and Pricing Risk, the Company also manages underwriting and claims risk through its Underwriting and Liability Risk Management Policy which governs each of its major product lines. This policy is established by the PMRC and approved by the Risk and Capital Committee of the Board. It defines the Company’s underwriting and claims management philosophy and sets out principles for prudent underwriting and claims management including, underwriting classification claims requirements, approval authorities and limits, and ongoing risk monitoring. The Company uses reinsurance to mitigate excessive exposure to adverse mortality and morbidity experience. The PMRC reviews and establishes retention limits for its various product lines and the Risk and Capital Committee of the Board recommends changes to these retention limits for approval by the board. (7) Reinsurance risk The Company is subject to the risk of financial loss due to inadequate reinsurance coverage or a default of a reinsurer. Amounts reinsured per life vary according to the type of protection and the product. The Company also maintains a catastrophe reinsurance program, which provides protection in the event that multiple insured lives perish in a common accident or catastrophic event. Although the Company relies on reinsurance to mitigate excessive exposure to adverse mortality and morbidity experience, reinsurance does not release it from its primary commitments to its policyholders and it is exposed to the credit risk associated with the amounts ceded to reinsurers. The availability and cost of reinsurance are subject to prevailing reinsurance market conditions, both in terms of price and availability, which can also affect earnings. Empire Life - Annual Report 2019 96 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands of Canadian dollars except for per share amounts, shares authorized and outstanding and where otherwise stated) The Reinsurance Risk Management Policy establishes reinsurance objectives and limits, and requires ongoing evaluation of reinsurers for financial soundness. As reinsurance does not release a company from its primary commitments to its policyholders, an ongoing oversight process is critical. The PMRC reports annually to the Risk and Capital Committee of the Board on reinsurance activities. Most of the Company’s individual life reinsurance (with the exception of its renewable term products) is on an excess basis (with a $500 retention limit), meaning the Company retains 100% of the risk up to $500 in face amount. With the Company’s renewable term products, however, all amounts over $100 are reinsured at an 80% level, meaning that the Company retains only 20% of the risk on coverage over $100, to a maximum retention of $500. In addition the Company also retains a maximum of $100 on individual accidental death policies. Retention amounts are lower for group business but are in addition to those noted for individual business. A portion of Empire Life’s segregated fund death benefit exposure is reinsured. All Empire Life segregated fund policyholders with death benefit guarantees of at least $2 million are included in this agreement. As a result of this reinsurance strategy, the Company utilizes lower than average levels of reinsurance, compared to Canadian competitors, and absorbs the resultant negative impact on short-term earnings due to additional sales strain. The Company does not have any assumed reinsurance business. Empire Life - Annual Report 2019 97 GLOSSARY OF TERMS (unaudited) Accumulated Other Comprehensive Income (AOCI) A separate component of shareholders’ and policyholders’ equity which includes net unrealized gains and losses on available for sale securities, unamortized gains and losses on cash flow hedges, unrealized foreign currency translation gains and losses and remeasurement of post-employment benefit liabilities. These items have been recognized in comprehensive income, but excluded from net income. Active Market An active market is a market in which the items traded are homogeneous, willing buyers and sellers can normally be found at anytime and prices are available to the public. Available For Sale (AFS) Finance Assets Non-derivative financial assets that are designated as AFS or that are not classified as loans and receivables, held to maturity investments, or held for trading. Most financial assets supporting capital and surplus are classified as AFS. Canadian Asset Liability Method (CALM) The prescribed method for valuation of policy liabilities in Canada. CALM is a prospective basis of valuation which uses the full gross premium for the policy, the estimated expenses and obligations under the policy, current expected experience assumptions plus a margin for adverse deviations, and scenario testing to assess interest rate risk and market risks. Canadian Institute of Actuaries (CIA) As the national organization of the Canadian actuarial profession, the CIA means to serve the public through the provision by the profession of actuarial services and advice of the highest quality. The CIA ensures that the actuarial services provided by its members meet accepted professional standards; and assists actuaries in Canada in the discharge of their professional responsibilities. Canadian Life and Health Insurance Association (CLHIA) The Canadian Life and Health Insurance Association (CLHIA) is an organization representing life insurance and health insurance providers in Canada. The industry develops guidelines, voluntarily and proactively, to respond to emerging issues and to ensure consumer interests are protected. Chartered Professional Accountants of Canada (CPA Canada) Canada's not-for-profit association for Chartered Professional Accountants (CPA) provides information and guidance to its members, students and capital markets. Working in collaboration with its provincial member organizations, CPA Canada supports the setting of accounting, auditing and assurance standards for business, not-for-profit organizations and government, and develops and delivers education programs. Earnings on Surplus This source of earnings represents the pre-tax earnings on the shareholders’ capital and surplus funds. Effective Interest Method The effective interest method is a method of calculating the amortized cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. Expected Profit from In-Force Business This source of earnings represents the profit Empire Life expects to generate on in-force business if experience is in line with the Empire Life’s best estimate assumptions for mortality, morbidity, persistency, investment returns, expenses and taxes. Experience Gains and Losses This source of earnings represents gains or losses due to the difference between actual experience and the best estimate assumptions. Empire Life - Annual Report 2019 98 GLOSSARY OF TERMS (unaudited) Fair Value Through Profit or Loss (FVTPL) Invested assets are classified as financial instruments at FVTPL if they are held for trading, or if they are designated by management under the fair value option. Most financial assets supporting insurance contract liabilities and investment contract liabilities are classified as FVTPL. Impact on New Business Writing new business typically adds economic value to a life insurance company. At the point of sale, new business may have a positive or negative impact on earnings. A negative impact (new business strain) will result when the provision for adverse deviation included in the actuarial liabilities at the point of sale exceeds the expected profit margin in the product pricing. The impact of new business also includes any excess acquisition expenses not covered by product pricing at the point of issue. International Financial Reporting Standards (IFRS) Refers to the international accounting standards that were adopted in Canada, effective January 1, 2011; these are now Canadian Generally Accepted Accounting Principles (CGAAP) for publicly accountable enterprises. Life Insurance Capital Adequacy Test (LICAT) The LICAT measures the capital adequacy of an insurer and is one of several indicators used by OSFI to assess an insurer's financial condition. The LICAT Ratio is the ratio of eligible capital to the base solvency buffer, each as calculated under OSFI's published guidelines. Management Actions and Changes in Assumptions This source of earnings component includes earnings generated by management actions during the year (e.g. acquisition or sale of a block of business, changes to product price, fees or asset mix, etc.) or the impact of changes in assumptions or methodology used for the calculation of actuarial liabilities for in-force business. Minimum Continuing Capital and Surplus Requirements (MCCSR) The ratio of the available regulatory capital of a life insurance company to its required regulatory capital, each as calculated under the Office of the Superintendent of Financial Institutions’ (OSFI) published guidelines. Other Comprehensive Income (OCI) Unrealized gains and losses, primarily on financial assets backing Capital and Surplus, are recorded as Other Comprehensive Income (“OCI”) or Other Comprehensive Loss (“OCL”). When these assets are sold or written down the resulting gain or loss is reclassified from OCI to net income. Remeasurements of post-employment benefit liabilities are also recorded as OCI or OCL. These remeasurements will not be reclassified to net income and will remain in AOCI. Office of the Superintendent of Financial Institutions Canada (OSFI) The primary regulator of federally chartered financial institutions and federally administered pension plans in Canada. OSFI’s mission is to safeguard policyholders, depositors and pension plan members from undue loss. Participating Policies The participating account includes all policies issued by the Company that entitle its policyholders to participate in the profits of the participating account. The Company has discretion as to the amount and timing of dividend payments which take into consideration the continuing solvency of the participating account. Return on Common Shareholders' Equity (ROE) A profitability measure that presents the net income available to common shareholders as a percentage of the average capital deployed to earn the income. Empire Life - Annual Report 2019 99 PARTICIPATING ACCOUNT MANAGEMENT POLICY Purpose The Participating Account Management Policy sets out the management objectives for oversight of the participating account of The Empire Life Insurance Company (“Empire Life” or the “Company”). Scope This policy applies to all policies issued in the participating account of Empire Life that entitle its policyholders to participate in the profits of the participating account. Most policies are credited with dividends annually, while a few older plans receive the dividends every five years as per contractual provisions. Policy Description of the Participating Account and its Policies Empire Life maintains an account in respect of participating policies (“participating account”), separate from those maintained in respect of other policies, in the form and manner determined by the Office of the Superintendent of Financial Institutions under section 456 of the Insurance Companies Act. The participating account includes all policies issued by Empire Life that entitle its policyholders to participate in the profits of the participating account. Empire Life does not maintain sub-accounts within the participating account for life, disability and annuity plans, other funds, or blocks of business acquired from other companies. Empire Life does not have any closed blocks of participating business established as part of the demutualization of a mutual company into a shareholder company. Investment Policy The general fund investments in the participating account are subject to limits established by the Insurance Companies Act and to investment guidelines established by the Investment Committee of Empire Life’s Board of Directors (the “Board”). The investment guidelines are designed to limit overall investment risk by defining investment objectives, eligible investments, diversification criteria, exposure, concentration and asset quality limits for eligible investments. The objective is to maximize investment yields while managing the default, liquidity and reinvestment risks at acceptable and measurable low levels. Within the participating account, Empire Life has established three asset segments to nominally match the investments to the specific type of liabilities or surplus as follows: Protection Par, Miscellaneous Insurance Par and Policyholders’ Surplus. Each asset segment is assigned specific assets in an amount approximately equal to its total liabilities or surplus. The Investment Committee receives monthly reporting on general fund asset mix and performance and investment transactions for all funds by asset segment. In addition, on at least a quarterly basis, management and the Company’s investment managers report to the Investment Committee, and through the Investment Committee to the Board of Directors, on portfolio content, asset mix, the Company’s matched position, the performance of general and segregated funds, and compliance with the investment guidelines. The investment guidelines are reviewed at least annually by the Board. Investment Income Allocation Investment income is recorded directly to each asset segment. A portion of investment income is allocated to or from the Shareholders’ Capital and Surplus segment from or to the participating account’s asset segments in proportion to the deficiency or excess of funds over assets of each segment. Expense Allocation General expenses are allocated to the participating account using cost centre methods. Expenses associated directly with the participating account are so charged. Expenses arising from or varying directly with various functional activities are charged to the participating account in proportion to statistics appropriate to each cost centre. Expenses incurred by overhead cost centers are charged to the participating account in proportion to expenses directly charged. Investment expenses are allocated monthly to the participating account in proportion to the Company’s total funds at the beginning of each month. Empire Life - Annual Report 2019 100 PARTICIPATING ACCOUNT MANAGEMENT POLICY Premium taxes are allocated in proportion to taxable premiums. Other taxes, licenses, and fees are allocated to lines of business using cost centre methods. Income Tax Allocation Income taxes are allocated to the participating account in proportion to total taxable income for the Company. Deferred tax assets and liabilities are treated consistently between participating and non-participating accounts. Surplus Management The level of surplus in the participating account will be managed by Company management taking into consideration the continuing solvency of the participating account, the participating account’s ability to fulfill all of its contractual obligations and the extent to which existing participating business is financing new participating business. Transfers to Shareholder Accounts It is Empire Life’s intention to transfer the full permitted percentage of distributable participating profits to the shareholder accounts as allowed by section 461 of the Insurance Companies Act. Appointed Actuary Annually, the Board will consider the Appointed Actuary’s opinion on the continuing fairness of this policy to participating policyholders. Process to Approve (and Frequency) This policy is reviewed annually by the Vice President & Product Actuary. All non-material amendments must be approved by the Product Management Review Committee. Material amendments must be approved by the Product Management Review Committee and the Board. The principal factors that would be expected to change the policy include changes in legislation, regulation of participating account, accepted actuarial practice, capital requirements, taxation and accounting rules or fundamental changes to the circumstances of the Company. This policy will also be reviewed if the Company decides to stop accepting new business in the participating account. Empire Life - Annual Report 2019 101 PARTICIPATING POLICYHOLDER DIVIDENDS AND BONUS POLICY Purpose The Participating Policyholder Dividends and Bonus Policy (the “dividend policy”) sets out the process for determining, recommending and declaring dividends for policies issued in the participating account of The Empire Life Insurance Company (“Empire Life” or the “Company”). Scope This dividend policy applies to each policy issued in the participating account of Empire Life that entitles its policyholder to participate in the profits of the participating account. Most policies are credited with dividends annually, while a few older plans receive the dividends every five years as per contractual provisions. Policy Dividends are Declared at the Discretion of the Board The aggregate amount of dividend and allocation of the dividend to the different classes of participating policies is declared annually at the discretion of the Board of Directors (the “Board”) of Empire Life under section 464(1) of the Insurance Companies Act. Before declaring the aggregate amount of dividend, the Board will consider Company management’s recommendations for policyholder dividends and the Appointed Actuary’s opinion on the conformity of the proposed dividend to this policy and its fairness to participating policyholders. Company management’s recommendations and the Appointed Actuary’s opinions shall be prepared in compliance with applicable legislative and regulatory requirements, and generally accepted actuarial practice with such changes as determined by the Office of the Superintendent of Financial Institutions. Principal Factors that Affect the Aggregate Amount of Dividends The aggregate amount of dividends will reflect operating income on all participating life, annuity and disability coverages, dividends on deposit, participating paid-up additions and participating term additions, as well as income attributable to surplus in the participating account. The aggregate amount of dividends will also be influenced by considerations such as, solvency of the participating account, its ability to fulfill all contractual obligations, the extent to which surplus in the participating account is financing new business, changes in legislation, regulation of the participating account, taxation, accounting rules or fundamental changes in the circumstances of the Company. Principal Sources of Income The principal sources of income considered for determining the aggregate amount of dividends are investment income, asset defaults, mortality, lapses, expenses and taxes. The actual experience of the participating account will be reviewed annually by Company management. The sources of income may be adjusted to smooth fluctuations in experience and provide for transitions during periods of major change over a period not to exceed five years. The Company uses a temporary contribution to policyholder surplus philosophy, so that contributions to policyholder surplus from participating account income are expected to be returned to policyholders over the lifetime of the policy. Since actual experience cannot be known in advance, the aggregate amount of dividends and allocation of the dividends cannot be guaranteed. As a result, dividends will increase or decrease depending on actual experience. Dividend Allocation Policyholders participate in this distribution through the setting of dividend scales, which allocate the aggregate amount of dividends among different dividend classes. The Company establishes dividend classes for participating policyholders based on the original pricing assumptions used when setting the guaranteed values provided by the policies. The Company uses a combination of factor-based and pricing methods when setting the dividend scale to allocate the aggregate amount of dividends among different dividend classes. The basic concept of this method is to allocate the aggregate amounts of dividends among dividend classes in the same proportion as the policies are considered to have contributed to the aggregate amount of dividends over the long term. The fundamental objective in the allocation of dividends is the maintenance of reasonable equity between dividend classes and between generations of policyholders, taking into account practical considerations and limits. Empire Life - Annual Report 2019 102 PARTICIPATING POLICYHOLDER DIVIDENDS AND BONUS POLICY Company management will review the underlying experience, assumptions and procedures for participating dividend scales annually. Material changes in actual experience will be passed through to participating policyholders within two years of the experience change to the extent that they are not anticipated in the current dividend scale. Company management will prepare a written report which describes the underlying experience, assumptions and procedures for the proposed dividend scale recommendations. The dividend scales may also be adjusted to reflect specific policyholder behaviour, such as experience for lapses or for policy loans taken at guaranteed rates. For certain blocks of policies, the policyholder dividend scale may be determined using methods which are designed to approximate the contribution to income of those blocks. Termination dividends are not payable under any participating policies issued by Empire Life. Appointed Actuary Annually, the Board will consider the Appointed Actuary’s opinion on the continuing fairness of this policy to participating policyholders. Process to Approve (and Frequency) This policy is reviewed annually by the Vice President & Product Actuary. All non-material amendments must be approved by the Product Management Review Committee. Material amendments must be approved by the Product Management Review Committee and the Board. The principal factors that would be expected to change the policy include changes in legislation, regulation of participating account, accepted actuarial practice, capital requirements, taxation and accounting rules or fundamental changes to the circumstances of the Company. This policy will also be reviewed if the Company decides to stop accepting new business in the participating account. Empire Life - Annual Report 2019 103 PARTICIPATING ACCOUNT FINANCIAL DISCLOSURE Participating Surplus Surplus and Accumulated OCI - beginning of year $ 36,163 $ 43,221 2019 2018 Net Income and OCI, before dividends Amounts transferred to shareholders per S.461 of the ICA Amounts transferred to shareholders per S.462(a) of the ICA, if included in net income Net Income and OCI Policyholder dividends, excluding ERRs Surplus and Accumulated OCI - end of year Total Participating Assets Section 462 transfer as a % of Distributable Profits 38,086 25,166 — (2,699) 35,387 — (2,100) 23,066 (31,438) (30,124) 40,112 36,163 $ 780,330 $ 692,355 7.61% 7.62% Empire Life - Annual Report 2019 104 CORPORATE GOVERNANCE OVER RISK MANAGEMENT The Empire Life Insurance Company (the “Company”) is a stock company that has both shareholders and participating policyholders. The Company also has a mutual fund subsidiary, Empire Life Investments Inc. (“ELII”). Pursuant to the Insurance Companies Act (Canada) (the “Act”) each holder of one or more participating policies is entitled to one vote in the election of policyholders’ directors, and each shareholder is entitled to one vote per share held in the election of shareholders’ directors. At least one-third of directors are elected as policyholder directors and the balance are elected as shareholder directors. The Company is governed by the Act, which contains provisions concerning corporate governance. The Company’s governance system is supported by internal audit, internal risk management, corporate compliance, external audit by an independent chartered accountants firm, and examination by the Office of the Superintendent of Financial Institutions Canada (“OSFI”). Management is responsible for identifying risks and determining their impact upon the Company. Management is also responsible for establishing appropriate policies, procedures, and controls to mitigate risks. The Company has senior management level risk committees, which report to the Board of Directors and/or its Committees and an internal risk management department, led by the Chief Risk Officer, which supports enterprise risk management activities across the Company. An internal audit function is responsible for assessing the adequacy and adherence to the systems of internal control. The results of internal audit’s reviews are reported to management and to the Audit Committee of the Board of Directors regularly throughout the year. Management is supervised in the completion of these responsibilities by the Board of Directors and its Committees. Senior management of the Company reports regularly to the Board on its risk management policies and procedures. The Board of Directors has plenary power. The Board’s responsibility is to oversee the conduct of the business and affairs of the Company including oversight and monitoring of the Company’s risk management. The Board discharges these responsibilities directly and through delegation to Board Committees and management. The Board met seven times in 2019 and is scheduled to meet at least six times in 2020. The risk management functions overseen by the Board include those relating to market risk (including interest rate risk, equity risk, real estate risk and foreign exchange rate risk), liquidity risk, credit risk, insurance risk (including mortality risk, policyholder behavior (termination or lapse) risk, expense risk, morbidity risk as well as product design and pricing risk, underwriting and claims risk and reinsurance risk), operational risk (including legal and regulatory compliance risk, model risk, human resources risk, third party risk and technology, information security and business continuity risk) and business and strategic risk. Please see the section titled “Risk Factors” in the Company’s Annual Information Form available at www.sedar.com for more details on these risks. Primary responsibility for oversight of some of these risks is delegated to five standing Committees of the Board, whose roles and responsibilities are specifically defined. Those not delegated to a standing Committee remain with the Board. The following is a brief summary of some of the key responsibilities of the five Committees. The Audit Committee has statutory responsibility under the Act to oversee, on behalf of the Board, the Company’s financial reporting, accounting and financial reporting systems and internal controls. The Committee also oversees work related to stress testing. The Investment Committee assists the Board in monitoring the Company’s investment and lending policies, standards and procedures and in monitoring the Company’s investment activities and portfolios. Some of the activities of the Investment Committee are prescribed by the Company’s Investment Guidelines, which reflect the requirements of the Act. The Committee also monitors the Company’s asset/liability management activities. The Human Resources Committee is responsible for reviewing and monitoring the Company’s human resources practices, including employee and executive compensation, succession planning, workforce and pension and benefit plans. The Conduct Review Committee is responsible for oversight of procedures established to identify material related party transactions pursuant to the Act. The Committee also monitors certain corporate policies, including procedures with respect to the Company’s Code of Business Conduct, conflicts of interest, the Company’s personal trading policy, confidentiality of information, consumer complaints, privacy, regulatory compliance and outsourcing. The Risk and Capital Committee is responsible for oversight of the Company’s risk and capital management activities. The Committee also assists the Board in its oversight role with respect to the management of the Company’s enterprise risk management framework and risk appetite framework; the identification, review and assessment of the Company’s primary risks; the review and assessment of the Company’s risk management strategies; and the deployment and use of capital. Empire Life - Annual Report 2019 105 CORPORATE INFORMATION Corporate Head Office 259 King Street East Kingston, Ontario Canada K7L 3A8 1 877 548-1881 info@empire.ca www.empire.ca RETAIL SALES OFFICES WESTERN CANADA Vancouver Retail Sales Office N302-5811 Cooney Road, North Tower Richmond, British Columbia V6X 3M1 604 232-5557 1 888 627-3591 Calgary Retail Sales Office 310-1167 Kensington Calgary, Alberta T2N 1X7 403 269-1000 1 800 656-2878 Winnipeg Retail Sales Office 200-5 Donald Street Winnipeg, Manitoba R3L 2T4 204 452-9138 1 866 204-1001 GROUP SALES OFFICES WESTERN CANADA Vancouver Group Sales Office N302-5811 Cooney Road, North Tower Richmond, British Columbia V6X 3M1 604 232-5558 1 800 547-0628 Calgary Group Sales Office 310-1167 Kensington Calgary, Alberta T2N 1X7 403 262-6386 1 888 263-6386 The Empire Life Insurance Company is a member of Assuris. Assuris is the not for profit organization that protects Canadian policyholders if their life insurance company fails. Details about Assuris’ protection are available at www.assuris.ca or by calling the Assuris Information Centre at 1 866 878-1225. ONTARIO Burlington Retail Sales Office 307-5500 North Service Road Burlington, Ontario L7L 6W6 905 335-6558 1 888 548-4729 Toronto Retail Sales Office 200 -36 York Mills Road Toronto, Ontario M2P 2E9 416 494-0900 1 888 548-4729 QUEBEC Montréal Retail Sales Office 1600-600 de Maisonneuve Boulevard W. Montréal, Quebec H3A 3J2 514 842-9151 1 800 371-9151 Québec Retail Sales Office 100-1220 Lebourgneuf Boulevard Québec, Quebec G2K 2G4 418 628-1220 1 888 816-1220 QUEBEC Montréal Group Sales Office 1600A-600 de Maisonneuve Boulevard W. Montréal, Quebec H3A 3J2 514 842-0003 1 800 561-3738 ONTARIO Burlington Group Sales Office 307-5500 North Service Road Burlington, Ontario L7L 6W6 905 335-6558 1 800 663-9984 Toronto Group Sales Office 200-36 York Mills Road Toronto, Ontario M2P 2E9 416 494-6834 1 800 361-7980 Empire Life - Annual Report 2019 106 BOARD OF DIRECTORS SHAREHOLDERS' DIRECTORS POLICYHOLDERS' DIRECTORS HONORARY CHAIRMAN John F. Brierley 1, 2, 5 Corporate Director Scott F. Ewert 1, 4, 5 Mark J. Fuller 2, 3, 5 The Honourable Henry N.R. Jackman President and Chief Executive Officer Honorary Chairman Ontario Pension Board The Empire Life Insurance Company Vice President and Chief Financial Officer Harold W. Hillier 1, 2, 3, 4 E-L Financial Corporation Limited Corporate Director HONORARY DIRECTOR The Right Honourable John N. Turner Edward M. Iacobucci 1, 2, 3 Mark Sylvia Dean, Faculty of Law University of Toronto Duncan N.R. Jackman 5 Chairman of the Board President and Chief Executive Officer The Empire Life Insurance Company Jacques Tremblay 3, 5 Partner The Empire Life Insurance Company Oliver Wyman Actuarial Consulting Clive P. Rowe 4, 5 Partner Oskie Capital Patricia M. Volker 1 Corporate Director 1 Member of Audit Committee 2 Member of Conduct Review Committee 3 Member of Human Resources Committee 4 Member of Investment Committee 5 Member of Risk and Capital Committee Empire Life - Annual Report 2019 107 CORPORATE MANAGEMENT Mark Sylvia President and Chief Executive Officer Richard Carty General Counsel and Senior Vice-President, Human Resources Edward Gibson Senior Vice-President, Chief Financial Officer and Chief Actuary Ian Hardacre Senior Vice-President and Chief Investment Officer Michael Perry Senior Vice-President, Group Solutions Steve Pong Senior Vice-President, Retail Kathy Thompson Senior Vice-President and Chief Risk Officer Empire Life - Annual Report 2019 108 This page has been left blank intentionally. E M P I R E L I F E A N N U A L R E P O R T 2 0 1 9 EMPIRE LIFE ANNUAL REPORT 2019 The Empire Life Insurance Company (Empire Life) is a proud Canadian company that has been in business since 1923. We offer individual and group life and health insurance, investment and retirement products, including mutual funds through our wholly-owned subsidiary Empire Life Investments Inc. Empire Life is among the top 10 life insurance companies in Canada1 and is rated A (Excellent) by A.M. Best Company2. Our mission is to make it simple, fast and easy for Canadians to build wealth, generate income, and achieve financial security. Follow us on social media @EmpireLife or visit www.empire.ca for more information. 1 Based on total assets as reported in December 31, 2018 OSFI filings 2 As at June 14, 2019. For the latest rating, access www.ambest.com. Transfer Agent and Registrar AST Trust Company (Canada) 1 Toronto Street, Suite 1200 Toronto, Ontario, M5C 2V6 Phone 416-682-3860 Toll Free 800-387-0825 www.astfinancial.com/ca-en Stock Exchange Listing Preferred Shares, Series 1 EML.PR.A Reporting Procedure for Accounting and Auditing Matters If you have a complaint regarding accounting, internal controls or auditing matters or a concern regarding questionable accounting or auditing matters, you should submit your written complaint or concern to: Mr. John Brierley The Empire Life Insurance Company 259 King Street East Kingston, ON, K7L 3A8 Email: jfbrierley@sympatico.ca Phone: 905-338-7290 You may submit your complaint or concern anonymously. Your submission will be kept confidential and will be treated in accordance with the Company’s policy for reporting accounting and auditing matters. ® Registered trademark of The Empire Life Insurance Company. ™ Trademark of The Empire Life Insurance Company. Policies are issued by The Empire Life Insurance Company. Insurance & Investments – Simple. Fast. Easy.® empire.ca info@empire.ca 1 877 548-1881 A-0004-EN-02/20 

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