Intact Financial Corporation
Annual Report 2007

Plain-text annual report

I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T Denny Morrison, Olympic silver medalist ING CANADA INC. 2007 ANNUAL REPOR T Driven to lead Performance against our business goals Historically, we have consistently exceeded the Canadian property and casualty industry growth rate and return on equity through superior underwriting and investment management. Business goals 10-year performance1 (1997–2006) 2007 performance1 Return on equity Exceed the Canadian P&C industry by at least 500 basis points (bps) annually ING Canada: 18.4% Industry: 10.2% Superior gap: 820 bps Organic growth Exceed the annual growth rate of the Canadian P&C industry by at least 300 bps over time, as measured by direct premiums written ING Canada: 13.8% Industry: 7.6% Superior gap: 620 bps ING Canada’s return on equity was 15.4 % in 2007 ING Canada’s direct premiums written grew 2.9 % in 2007 1 Industry data for the full year of 2007 was not available as of the date of this report. See Management’s Discussion and Analysis for further discussion of our financial performance. d ROE performance of our insurance subsidiaries compared to Canadian P&C insurance industry (10-year average, 1997–2006) ING Canada premium1 growth vs. industry (10-year CAGR, 1997–2006) 40% 30% 20% 10% 0% 18.4% Canadian industry1 10.2% 600% 500% 400% 300% 200% 100% 0% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1 Based on most recent industry data (2006) Source: MSA Research Software. P&C industry statistics include reinsurers and exclude Lloyd’s and the Insurance Corporation of British Columbia (ICBC) 1 Based on direct premiums written 2 Source: MSA Research Software. P&C industry statistics include reinsurers and exclude Insurance Corporation of British Columbia (ICBC). Most recent industry data available (2006) 13.8% Canadian industry2 7.6% ING Canada Inc. provides automobile, property and liability insurance to more than four million market share, we are the largest private sector provider of property and casualty (P&C) insuranc We also manage our own investment portfolio with more than $7.2 billion in assets. What drives our success Our consistently superior performance has been driven by several critical advantages: scale, underwriting discipline, in-house claims expertise, innovative products, a diverse business portfolio, proven acquisition and integration capabilities, and investment management expertise. Significant scale advantage ING Canada is one-third larger than the second largest P&C insurer in Canada and almost double the size of the number three insurer. The key benefit of scale is a uniquely comprehensive database of customer data and claims intelligence that allows us to more accurately model the risk of each policy. Scale also allows us to negotiate preferred terms with suppliers, priority service on repairs, quality guarantees and lower material costs. Discipline in underwriting and pricing Our scale makes it possible to more accurately assess individual risks to create a pricing edge and continue to increase the sophistication of our pricing models. Whether writing a policy for an 18-year-old sports car driver, a florist shop, a condominium or a commercial building, we set premiums that are intended to attract and retain business without compromising target returns in our portfolio. In-house claims expertise Innovativ We handle more than 95% of claims in-house. In-house claims management is more cost-effective and it allows us to process claims faster, retain better control over claims management, and provide a consistent customer experience that reflects our brand attributes. In 2007, we had a 95% customer claims satisfaction rate. We are con new produc evolving ne Our Respon for example new custom New Brunsw feature, but who have b years or mo we have wo expand our Our staff of prevention s more than 9 and over 4, Becoming the “first choice” partner for brokers Direct premiums written1 ($ billions) 2007 direct premiums written by geographic region ($ millions) “ING Insurance recognizes the value of the broker channel and is a big supporter of entrepreneurial brokers who want to grow their businesses. The tools and services they provide through QUEST, such as financing, marketing and technological solutions, help us focus on what’s important: the client.” $4.0 $3.1 $4.0 $3.0 $2.0 $1.0 $0.0 $2.1 $1.9 $1.8 ING Aviva Canada Co-operators General The Economical Insurance Group TD Meloche Monnex Estimated market share 11.4% 8.7% 5.9% 5.4% 5.1% 1 Based on most recent industry data (2006) Source: MSA Research Software. P&C industry statistics include reinsurers and exclude Lloyd’s and the Insurance Corporation of British Columbia (ICBC) Yukon $3.9 Northwest Territories $7.8 British Columbia $234.7 Alberta $826.0 Manitoba $54.6 Saskatchewan $2.6 Ontario $1,744.9 John Collaton Independent broker, Ontario gate2 ur million individuals and businesses across Canada. With an estimated 11% insurance in Québec, Alberta and Nova Scotia and the second largest in Ontario. Innovative products Proven acquisition strategy We are constantly developing new products that cater to the evolving needs of our customers. Our Responsible Driver Guarantee, for example, is available to new customers in Ontario and New Brunswick as a premium policy feature, but is free to customers who have been with us for five years or more. In commercial lines, we have worked aggressively to expand our loss prevention services. Our staff of more than 40 loss prevention specialists conducted more than 9,500 site visits in 2007 and over 4,000 building appraisals. The Canadian P&C insurance industry is fragmented. The top five companies make up only 35% of the market, which creates opportunities for consolidation. ING Canada has been one of the most active in the industry’s transformation with more than 11 acquisitions in 19 years. Growth through acquisition has enabled us to rapidly gain a scale advantage in the market. Investment management expertise We actively manage our investment portfolio to generate solid after-tax returns while balancing capital preservation and diversification of risk. Our portfolio is comprised primarily of Canadian securities, including high-quality fixed income securities, common shares of large-cap companies and preferred shares. We’ve chosen to manage our portfolio in-house to ensure commitment to our investment philosophy and business goals. Diverse business portfolio The diversity in our business portfolio is derived from our multi-channel distribution strategy as well as our business mix and geographic distribution. Our diversity provides some insulation from cyclical movements and creates greater opportunities for growth. 2007 investment asset mix1 (%) 2007 direct premiums written by business line (excluding pools) (%) ING Canada’s business is entirely Canadian, which reduces exposure to severe storms, like tornadoes and hurricanes, and unnatural disasters. In certain regions in Canada, climate change is having a larger impact on the insurance industry, leading to an increase in the frequency and severity of storms. Personal auto regulation in certain provinces increases operational complexity for the industry. Newfoundland & Labrador $1.3 ($ millions) ($ millions) Common shares 24% $ 1,709.5 Personal auto 50% $ 2,057.7 Fixed income 53% $ 3,867.8 Personal property 22% $ 904.4 Preferred shares 20% $ 1,430.8 Commercial auto 8% $ 321.2 Other 3% $ 229.7 Commercial non-auto 20% $ 825.3 oba Ontario $1,744.9 Québec $1,037.2 Prince Edward Island $8.3 Nova Scotia $130.6 New Brunswick $49.4 1 Fair value, as at December 31, 2007 The company has a zero cash policy Personal insurance makes up the largest segment of ING Canada’s underwriting business with more than 70% of direct premiums written. Though commercial insurance represents only 30% of our annual premiums, we are the largest competitor in our target segment of small- to medium-size businesses. Smaller commercial accounts are easier to underwrite and less susceptible to cyclical pricing vagaries. I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T gate3 We are driven to lead the Canadian property and casualty insurance market. As the largest competitor, we combine the advantages inherent in our scale with critical strengths in pricing, underwriting, claims and distribution. This allows us to offer competitively priced products and outstanding service to our customers and brokers and, in turn, achieve superior financial results. MESSAGE FROM THE PAST CHAIRMAN 2 MESSAGE FROM THE CHAIRMAN 3 MESSAGE FROM THE CHIEF EXECUTIVE OFFICER 4 DRIVING LEADERSHIP PERFORMANCE 6 MANAGING INDUSTRY CYCLICALITY, SEASONALITY & REGULATION 8 EXECUTIVE MANAGEMENT TEAM 12 MANAGEMENT’S DISCUSSION AND ANALYSIS 13 CONSOLIDATED FINANCIAL STATEMENTS AND NOTES 53 REVIEW 93 GLOSSARY 94 SHAREHOLDER AND CORPORATE INFORMATION INSIDE BACK COVER FINANCIAL HIGHLIGHTS 10 CORPORATE RESPONSIBILITY 11 BOARD OF DIRECTORS AND EXECUTIVE MANAGEMENT 96 FIVE-YEAR ANNUAL REVIEW 92 TWO-YEAR QUARTERLY I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 1 Message from the Past Chairman Yves Brouillette As stewards of the organization, the Board continues to represent the best interests of shareholders through a strong focus on corporate governance. In 2007, ING Canada employees continued to prove the strength of our business model and strategies with industry- leading performance. Building our leaders As key advisors to management in the development of the organization’s strategy, it is critical that the Board regularly reviews and assesses its own strengths against the organization’s evolving needs. As a result, in 2007, the Board launched the use of our own competency grids that outline the desired complement of directors’ skills and characteristics that reflect ING Canada’s current and anticipated needs. “ Renewal and succession are not only important from a Board perspective, but ensuring we attract, retain and develop high-performing executive management is also a critical function of the Board. With this in mind, I was very pleased with the appointment of Charles Brindamour as our new Chief Executive Officer. ” The Board has been able to observe first-hand Charles’ excellent track record here at ING where he has demonstrated strong leadership abilities. He has led a wide range of our operations here in Canada and abroad and was instrumental in the development and execution of the vision and strategy. We have full confidence that he will put his own successful mark on the strategic course set by his predecessor. A word of thanks Claude Dussault retired after a long and distinguished career, which included 22 years of dedicated service to ING Canada. As Chief Executive Officer for the past six of those years, Claude has been the main architect of our growth strategy, and under his leadership the company acquired and integrated two large insurance companies and launched one of the largest and most successful initial public offerings, making ING Canada one of the top 100 companies in Canada. He has demonstrated a great intellect and outstanding business acumen and we are privileged to continue benefiting from his experience and advice as our new Chairman of the Board. In addition, I would like to take this opportunity to thank David Wheat, who stepped down from the Board at the end of 2007, in recognition of his service to shareholders. For the past six years, I have had the honour and privilege of chairing the Board of Directors of ING Canada. I am proud of our accomplishments and I want to thank both my colleagues on the Board and the talented ING Canada staff for their hard work and dedication. I look forward to continuing to play a role by remaining a director of this leading organization. Yves Brouillette Past Chairman Board of Directors Charles Brindamour 4 Yves Brouillette 3,5 Paul Cantor 1,2,5 Marcel Côté 1,3,5* Robert W. Crispin 4* Claude Dussault 3,4 1 Independent board member 2 Audit & Risk Review Committee 3 Conduct Review and Corporate Governance Committee 4 Investment Committee 5 Human Resources Committee * Committee Chair 2 Message from the Chairman Claude Dussault I am honoured to continue being associated with ING Canada’s success and serving as your Chair. 2007 was a year of great activity and considerable competition within the Canadian property and casualty insurance industry. Despite a challenging year, ING Canada’s organic growth remained solid and our profitability continued to outpace the industry. Your Board of Directors continued to make an important contribution in its complementary role of representing shareholders and advising and supporting the management team on issues related to the company’s performance and strategy. We believe the foremost purpose of the Board is to create an environment for management that fosters integrity and promotes long-term shareholder value. Committed to good governance Good corporate governance mitigates risks, fosters a performance culture and provides a solid platform to deliver leading financial returns. For these reasons, we are committed to continuously improving our governance. For example, in 2007, ING Canada adopted the Insurance Bureau of Canada’s Standards of Sound Marketplace Practice. The primary objective of the IBC Standards is to encourage the adoption of a more risk-based model for the insurance regulatory environment and improve corporate governance to better protect consumers’ interests. “ At ING Canada, we believe that the best way to approach compliance is not to simply see it as a means of managing risk, but to approach it from the same perspective as we do everything else in our organization, from the perspective of our customers. This customer focus can also be seen in the Board’s commitment and ongoing support of our robust enterprise risk management framework. ” We also aligned the Board’s interests more closely with those of our shareholders through increased share ownership requirements for our directors and guidelines regarding serving on other boards, which will help us avoid any conflicts of interest. Many challenges await the industry in 2008, with each holding the potential for further success. On behalf of the Board of Directors, I would like to take this opportunity to thank all of our employees across the country for their contribution to ING Canada’s performance over the past year. I would also like to take this opportunity to thank my predecessor, Yves Brouillette, for his many years of leadership to the Board. I am honoured to continue being associated with ING Canada’s success and to serve as your Chair. Your Board looks forward to continuing to provide counsel and support to ING Canada’s outstanding management team, as they implement the next phase of the organization’s exciting growth strategy. Claude Dussault Chairman Please refer to the corporate governance section of ING Canada’s web site at www.ingcanada.com for more information on Board and committee mandates, director independence, director compensation, executive compensation and the company’s Code of Business Conduct. Biographies of each of the directors of the Board are also available. Ivan E.H. Duvar 1,2*,3 Eileen Mercier 1,2,3* Kathleen Murphy 4 Robert Normand 1,2,4 Louise Roy 1,5 Carol Stephenson 1,5 I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 3 Message from the Chief Executive Officer Charles Brindamour One of the greatest challenges for any industry leader is sustaining the top position. “ With $4.1 billion in annual premiums, we are the largest property and casualty insurer in Canada by a wide margin and the most active in the industry’s consolidation over the last 10 years.” But our goal is not to be the biggest P&C company in Canada; we’re driven to be the best. We want to deliver industry-leading rates of return and grow at a faster rate than our competition in Canada by offering a superior suite of products and services to our brokers and customers. We’ve set aggressive targets to keep us on track to outperform—exceed the industry return on equity by five percentage points per year and grow by three percentage points more than the industry over time. This is not an easy task, but I firmly believe that we have several key advantages to help us get there: scale, underwriting sophistication, actuarial talent, strong broker relationships, and a team of experienced senior leaders and employees who are passionate about our business. If we continue to build upon these strengths and stay focused on meeting the evolving needs of our customers and brokers, I am confident that we will continue to lead the market and achieve the high performance standards that we’ve set for ourselves. Key accomplishments in 2007 We made considerable progress on a number of fronts to position our business for sustainable growth and profitability. In pricing, we continued to refine our risk selection criteria and enhanced the sophistication of our underwriting models. These proprietary tools help us to assess the lifetime value of a customer relationship and are used as the basis of our pricing and product strategies. On the claims side, we expanded our preferred supplier relationships and looked for opportunities to negotiate national pricing contracts for auto parts and building materials which we buy in high volume. Beyond pricing and claims, the relationships that we have with our brokers are critically important to our long-term strategy so we continued to focus on ways to improve the service that we offer to them. Major technological enhancements to speed up data exchange, improved workflows, and better communication through our regional representatives and underwriters have made it easier for brokers to do business with us. A strong focus on customer needs is the emphasis of our strategy for belairdirect and Grey Power as well. At belairdirect, we implemented several technology and service-based improvements on the web and in the call centres to position belairdirect as the leading web insurer in Canada. Grey Power also made an impressive transformation last year in terms of operational efficiency, setting the stage for continued profitable growth in the future. To support all of our businesses, we made advancements in talent management, including succession planning and workplace diversity. Our financial performance in 2007 Overall, we delivered solid operating results in 2007. Premiums continued to grow at a good pace in personal lines and we maintained our commercial pricing discipline in the midst of stiff competition. Underwriting results were challenged by certain industry-wide cost factors, but our business remained very profitable, picking up speed toward the end of the year. On the investment side, the severity of the capital market events in 2007 resulted in lower investment results than we expected, even though our portfolio is mainly comprised of very high-quality Canadian securities. In total, we delivered strong financial performance with a return on equity of 15.4%, which is well above the industry long-term average. Industry performance and outlook Over the past few years, consumers have enjoyed very favourable rates across all lines of business. At the same time, industry returns have been very healthy, reaching peak levels in 2004–2005. Solid performance continued into 2007, but came down from historical highs due to an increase in claims costs and more aggressive pricing in the commercial segment. In claims, changes in weather patterns, higher labour rates and material costs have all put pressure on underwriting results across the industry. In addition, medical claims have started to creep up in Ontario, indicating potential erosion in the provincial reforms. In Alberta, the regulatory cap on pain and suffering awards for minor injuries was lifted in early 2008, a decision which is being appealed by the Alberta government. To support ongoing favourable conditions for consumers, we anticipate that industry participants will modify their value propositions to reflect emerging trends. Regulators are equally sensitive to these trends and will likely take steps to ensure the product evolves to address the changing dynamic of the marketplace. 4 Direct premiums written ($ millions) Written insured risks (thousands) Net income ($ millions) Net gains on invested assets and other gains Net operating income $ 5,000 $ 4,000 $ 3,000 $ 2,000 $ 1,000 $ 0 $3,906 $3,994 $4,109 $3,501 2004 2005 2006 2007 5,000 4,000 3,000 2,000 1,000 0 4,418 4,565 4,680 3,858 2004 2005 2006 2007 $ 800 $ 600 $ 400 $ 200 $ 0 $169.5 $612.3 $91.9 $532.3 $127.5 $530.5 $38.3 $470.0 2004 2005 2006 2007 National Speed Skating team and our multi-year sponsorships of the Edmonton and Ottawa Marathons to promote healthy living for Canadians. For the coming year Our focus is to build upon the positive momentum in our businesses while continuing to seek out further acquisition opportunities in Canada. We also plan to utilize some of our excess capital through a higher dividend and a normal course issuer bid to buy back up to 6.2 million shares, both of which we announced in February 2008. Our strong capital base provides the flexibility to return capital to our investors while retaining our strategic flexibility. And finally, I would like to recognize the members of our Board for their guidance and stewardship of our organization as we set the course for future growth at ING Canada. Specifically, I would like to thank my predecessor Claude Dussault for his leadership and tremendous support over the years. We are very fortunate to benefit from the wealth of his experience as Chairman of our company. I would also like to highlight the tremendous efforts of our 6,500 employees and 1,800 brokers across Canada. It is through their unabated commitment that we are able to turn our actions into achievements and make our mark as one of the top- performing companies in Canada. Charles Brindamour Chief Executive Officer We expect to see some rate strengthening in personal lines across the industry reflecting an increase in costs as well as continued price pressure on commercial accounts. In our view, profitability and premium growth will continue moving in the direction of industry long-term averages. If capital market volatility persists through 2008, it could also affect total returns over the coming year. Increasing our performance advantage In order to accelerate our growth and beat industry results over time, we have developed a long-term strategy to deliver an unrivalled product and service offering for our customers and brokers. Our strategy is focused on four main pillars described on the following pages: 1) Invest in people; 2) Excel at the fundamentals; 3) Focus on the customer; and 4) Strong distribution. For 2008, we will focus on advancing these core strategies and stay sharp, disciplined and ready to pursue acquisition opportunities that fit within our core businesses and are priced right. Becoming the “first choice” partner for brokers We fundamentally believe that customers value the benefits offered by insurance brokers, including community presence, personal advice and advocacy. So we have made Strong distribution a cornerstone of our strategy to ensure that we never lose sight of the importance of a strong service proposition to our brokers. In 2008, we will continue to invest meaningfully in our broker channel through comprehensive training for customer service representatives, shared marketing campaigns, best-in-class technology and financing options to enable entrepreneurial brokers to expand. With a large demographic segment of Canadian consumers and businesses relying more heavily on brokers for advice as their physical assets grow, brokers who are committed to building on their strengths will be well-positioned to succeed. Leadership in our communities ING Canada is committed to improving the quality of life in the communities in which we live and operate. The ING Foundation, through its Chances for Children programs, continued to support causes and charitable organizations that inspire leadership and independence in Canadian youth and empower them to achieve their full potential. In addition, we provide sponsorships to organizations that best reflect our values, such as our role as a Premier Partner of Canada’s I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 5 Driving leadership performance Effective risk pricing and efficient claims management are table stakes for a top-performing P&C insurer. Strong capital and investment management capabilities are also essential skills for sustainable results in this industry. These are our strengths and we will continue to focus on them to maintain our high level of execution excellence, but we never stop innovating and looking for ways to enhance our competitive edge. Our four-pillar strategy is designed to reinforce our core strengths and reflect our hallmark performance culture: Invest in people Excel at the fundamentals Focus on the customer Strong distribution Focus on attracting, developing and retaining top talent, and providing them with the tools, environment and rewards that inspire best-in-class performance and customer-centricity. Leverage our size and experience in pricing and claims to operate more efficiently, reduce claims costs, identify market trends earlier while also optimizing our capital and investment management skills. Offer products and services that reflect our brand attributes: “easy to deal with,” “treats me fairly,” and “delivers on promises.” We will do this by leveraging technology, identifying growing consumer segments and tailoring new products to their evolving needs. Support entrepreneurial brokers in growing their businesses and make it even easier for them to do business with us because we believe that in order to be successful we need to help our brokers to be successful. Offer additional channels of distribution to let our customers decide how they would like to do business with us. 6 Offering choices to customers Our distribution strategy is ready to meet the challenges of an evolving marketplace and is aimed at maximizing growth while catering to the needs of a broader consumer demographic. We market our distribution channels through the following brands: ING Insurance In an age of ever-changing, high-tech communications, many customers maintain there is no substitute for the personal, community-based service that brokers provide, which puts our ING Insurance brokers at the heart of our distribution strategy. With over 1,800 broker relationships in 3,300 locations across the country, ING Insurance has continued to grow and thrive because of its commitment to help brokers across the country build their businesses and deliver the best products and services to their customers. ING Insurance is our largest distribution channel and makes up roughly 77% of our annual direct premiums written. belairdirect For consumers who prefer making purchases by telephone or over the Internet, belairdirect has been providing complete home and auto insurance solutions directly to consumers in Ontario and Québec for over 50 years. With belairdirect, consumers have the option of buying coverage over the phone, via the Internet, or in person. belairdirect is the most recognized direct-to-consumer insurance brand in its markets. 2007 direct premiums written by distribution channel (%) ($ millions) Brokers 77% $ 3,156.3 Affiliated distribution network brokerages 12% $ 499.0 belairdirect 11% $ 453.3 Grey Power Specializing in the insurance needs of the 50+ market since 1993, Grey Power offers carefully selected products and services that recognize years of experience and safe driving and operate under the belief that consumers should reap the rewards of maturity through better rates. Canada Brokerlink Canada Brokerlink (CBL) is the fourth largest and fastest growing brokerage in Canada. A wholly owned subsidiary of ING Canada, CBL offers consumers products and services from a number of insurance companies, including ING Insurance. Consolidator in a fragmented market Time and time again we have demonstrated that we can successfully take advantage of the consolidation of the Canadian P&C market by buying and fully integrating acquired businesses efficiently, effectively and profitably. Our acquisition strategy is based on buying underperforming books of business that fit within our core business lines. To create value, we use our scale and skills in underwriting to price each policy fairly and reduce claims costs while retaining a high percentage of policies on renewal. Our objective is to reduce the loss ratio and increase the overall margin from the same book of business. In a marketplace that is still highly fragmented, with the top five players making up only 35% of the market, we believe there are many opportunities for further consolidation in Canada. Acquisition history Year of acquisition Approximate size of acquisition (DPW)1 ($ millions) Allianz Canada (Personal and small to medium commercial lines) Zurich (Personal and small commercial lines) Pafco (Niche products) Guardian Canadian Surety (Personal lines, selected provinces) Wellington St. Maurice Constitution Metropolitan General Commerce Group/Belair Western Union 1 Direct premiums written 2004 2001 1999 1998 1997 1995 1994 1992 1991 1989 1988 600 510 40 630 30 370 30 30 10 290 60 I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 7 Managing industry cyclicality, seasonality & regulation Industry cyclicality, seasonality and regulation add operational complexity to the P&C industry in Canada. However, with ING Canada’s scale and other distinctive strengths, we can more successfully manage these external factors and differentiate ourselves as a leader in the market. Cyclicality Over the past 30 years, returns in the property and casualty insurance industry have fluctuated substantially with an average return on equity of roughly 10% over that period. Cyclicality is driven by a combination of factors including capital management, time lags, and industry regulation which are described in the following table. We are able to manage the cycle pattern to our advantage by identifying unexploited profit pockets in the market. Canadian P&C industry – return on equity (1975–2006) 25% 20% 15% 10% 5% 0% 1975 30-year average – 10.3%* Average ROE 12.3% Average ROE 11.4% Average ROE 11.0% Average ROE 8.9% 10-year ROE outperformed industry by 820 bps 1980 1985 1990 1995 2000 2005 * Based on most recent industry data (up to 2006) Source: IBC and MSA 8 Inefficient industry capital management Time lag Regulatory/political process Decentralized decision-making – Performance in the insurance industry is driven by supply, not demand – When capital in the industry is plentiful, some companies will under-price business to gain market share rapidly. Inadequate pricing squeezes underwriting margins. Ultimately prices need to rise again to recover the losses, repeating the cycle pattern – This is more prevalent in commercial insurance than in personal insurance – There can be several years – In provinces where rates are – In some cases, individual regulated, approvals can take several weeks due to the complexity of the regulatory process underwriters and brokers have the ability to negotiate premiums—particularly with large commercial clients—in order to capture business between the time a policy is priced and the full cost of a claim is known (e.g., personal auto claims can have a longer duration due to medical costs included) – Pricing is based on actual experience over the previous three to five years, with adjustments typically made after trends develop – Premiums are recognized over the term of the policy Technical premium pricing strategy Identifying industry market inefficiencies $ Profit pockets Market price Time Four-year average ING seasonal indicator1 1.1 1.0 0.9 First quarter Higher combined ratio Lower combined ratio Second quarter Third quarter Fourth quarter 1 The seasonal indicator is a non-GAAP measure which represents the ratio of the quarterly combined ratio to the annual combined ratio. Even in a soft cycle, there are market segments that are priced more attractively than others. By pursuing the most profitable segments and not under-pricing existing business, we can increase the superior gap between our performance and that of the industry. Seasonality Underwriting performance is also subject to seasonal fluctuations, related primarily to automobile claims patterns and winter driving conditions. Typically, claims are higher in the first and fourth quarters due to slippery roads and poor visibility. Severe winter weather storms, such as the 1998 ice storm, as well as rain, wind and hail can affect property insurance results. Areas with inadequate sewer systems are particularly vulnerable to more water-related property damages. As the largest P&C insurer, we quickly identify and react to new weather trends because we have access to the largest database of customer claims data upon which we base our statistical modelling. Our preferred supplier networks help speed up the cycle time of each claim which reduces costs and increases customer satisfaction. Industry auto regulation in Canada Automobile insurance rates are regulated in certain provinces, including Ontario and Alberta, which are the largest private insurance markets in Canada. While the rate approval process and timing varies by province, in Ontario and Alberta, insurers must file for rate adjustments before they can be effected. In addition, several provinces have instituted certain automobile insurance reforms to ensure the affordability and accessibility of insurance coverage. These reforms have been largely effective at stabilizing costs, supporting lower annual premiums for consumers, but the reform benefits tend to lose their effectiveness over time. To address this issue, automobile insurance regulators are focused on responding to the concerns of all stakeholders and are taking positive steps to stay abreast of developments in the claims environment. I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 9 Corporate responsibility At ING Canada, we are deeply respectful of each other, our customers, our partners and the environment in which we operate. This commitment is demonstrated by the following activities in five key areas: Community (cid:2)(cid:2) Employees Governance (cid:2) – The ING Foundation supports – Conducted our annual employee – ING Canada employees review our Code organizations that empower Canada’s next generation of leaders, such as Youth in Motion’s Top 20 Under 20 award and the kids.now mentoring program. – Support employee giving and volunteerism through our Employee Community Giving Program. – Matched the ING Canada employee donations to the United Way dollar for dollar, resulting in an annual total of almost $1 million. – Premier Partner of Canada’s national speed skating teams and support of local community initiatives to help develop the sport among youth. satisfaction survey and communicated results and related action items to employees. – Established a Diversity Council in 2006 with an initial focus on gender diversity. To date, the council has supported two programs, mentoring and formal flexible work arrangements. In addition we have increased representation of women in our succession pool. – Introduced our Employee Share Purchase Plan in 2006. Employee enrolment has reached over 35%. – All permanent, full-time and part-time employees have access to our short-term incentive plan based on personal and company performance. of Business Conduct annually. – Anonymous whistle-blower hotline is available to all employees. – Aligned the Board’s interests more closely with those of our shareholders through increased share ownership requirements for our directors and guidelines regarding serving on other boards, which will help avoid any conflicts of interest. Further information on ING Canada’s corporate governance is provided in the Company’s Management Proxy Circular which is available on the System for Electric Document Analysis and Retrieval at www.sedar.com, or in the investor relations section of ING Canada’s web site at www.ingcanada.com. Environment (cid:2)(cid:2) Customers – Report internally and participate in ING Group’s Carbon Disclosure Project submission and carbon neutral commitment. – In 2007, ING Canada began phasing out paper pay stubs and moved to an on-line system. Over 56% of ING Canada’s 6,500 employees are enrolled and all new ING Canada employees are enrolled automatically. – Launched belairdirect’s e-docs initiative, giving customers the ability to view, print and save their automobile insurance documents on-line. – Collaborated with BASF Canada to promote the use of waterborne auto paint among the Rely Network of preferred repair shops. – Adopted the Insurance Bureau of Canada’s Standards of Sound Marketplace Practice to better protect consumers’ interests. – Conduct ongoing customer satisfaction surveys to measure the quality of our claims service. – Developed a new user-friendly billing statement that is easier for our customers to read and understand. – 24/7 Claims Service Guarantee ensures when a policy holder has a claim emergency they are transferred to an ING adjustor immediately, or that an ING representative will call them back within 30 minutes of their first call. – We’ll take your word for it – At ING Insurance, when a customer files an auto claim, we pay collision claims based on their version of events. ING’s global green initiatives For the second year in a row, ING Group has been named a “best in class” company in the Carbon Disclosure Project’s Climate Leadership Index. ING Group has also committed to becoming carbon neutral through increased energy efficiency, purchasing green energy wherever possible and compensating for all remaining CO2 emissions through reforestation. I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 11 Executive management team One of the cornerstones of our long-term strategy is ”invest in people.” We place great importance on attracting, developing and retaining talented senior leaders. Martin Beaulieu Senior Vice President, Personal Lines Charles Brindamour President and Chief Executive Officer Jetse de Vries Senior Vice President, Western Canada Louis Gagnon Senior Vice President, Québec Denis Guertin Senior Vice President, belairdirect Alan Blair Senior Vice President, Atlantic Canada Debbie Coull-Cicchini Senior Vice President, Ontario Claude Désilets Chief Risk Officer Françoise Guénette Senior Vice President, Corporate and Legal Services, and Secretary Louis Héroux Senior Vice President, Claims Jack Ott Senior Vice President and Chief Information Officer Marc Provost Senior Vice President, Managing Director, and Chief Investment Officer, ING Investment Management Mark Tullis Chief Financial Officer Derek Iles President, ING Insurance Marc Pontbriand Executive Vice President Roger Randall Senior Vice President, Affiliated Distribution Networks Peter Weightman Senior Vice President, Commercial Lines For biographies on our executive management team go to www.ingcanada.com. 12 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 13 Management’s Discussion and Analysis February 19, 2008 The following Management’s Discussion and Analysis (“MD&A”), which was approved by the Board of Directors for the quarter and year ended December 31, 2007, should be read in conjunction with the company’s Audited Consolidated Financial Statements and accompanying notes. The company uses both generally accepted accounting principles (“GAAP”) and certain non-GAAP measures to assess performance. Non-GAAP measures do not have any standardized meaning prescribed by GAAP and are unlikely to be comparable to any similar measures presented by other companies. ING Canada analyzes performance based on underwriting ratios such as combined, general expenses and claims ratios as well as other performance measures. These measures are defined in the company’s glossary on page 94 of the 2007 Annual Report. The glossary is also posted on the ING Canada web site at www.ingcanada.com. Click on “Investor Relations” and “Glossary” on the left navigation bar. “ING,” “ING Canada” and “the company” are terms used throughout the document to refer to ING Canada Inc. and its subsidiaries. FORWARD-LOOKING STATEMENTS differ materially from these forward-looking statements as a result of various factors, including those discussed below or in the company’s Annual Information Form. Please read the cautionary note in section 10.2 of this document. Certain totals, subtotals and percentages may not agree due to rounding. Additional information about ING Canada, including the Annual Information Form, may be found online on SEDAR at www.sedar.com. This document contains forward-looking statements that involve risks and uncertainties. The company’s actual results could A change column has been provided for convenience showing the percentage variation between the current period and the prior period. Not applicable (“n/a”) is used to indicate that the current and prior year figures are not comparable or if the percentage change exceeds 1,000%. Not material (“n/m”) is used when figures are not significant. TABLE OF CONTENTS 14 Performance highlights Section 1 – ING Canada 15 1.1 Overview of the business 16 1.2 Critical capabilities 17 1.3 Key performance indicators Section 2 – Canadian property and casualty industry outlook Section 3 – Overview of consolidated performance 19 3.1 Financial results 19 3.2 Explanation of financial results 21 3.3 Recent events 22 3.4 Underwriting 23 3.5 24 3.6 Net (losses) gains on invested assets and other gains 25 3.7 Net operating income 25 3.8 Selected quarterly information 26 3.9 Selected annual information Interest and dividend income, net of expenses Section 4 – Personal lines 26 4.1 Financial results 27 4.2 Explanation of financial results Section 5 – Commercial lines 28 5.1 Financial results 29 5.2 Explanation of financial results Section 6 – Corporate and distribution 30 6.1 Financial results 30 6.2 Explanation of financial results Section 7 – Financial condition 31 7.1 Balance sheet highlights 32 7.2 Portfolio of invested assets 35 7.3 Claims liabilities 36 7.4 Reinsurance 38 7.5 Liquidity and capital resources 39 7.6 Contractual obligations 39 7.7 Off-balance sheet arrangement Section 8 – Accounting and disclosure matters 39 8.1 Disclosure controls and procedures 39 8.2 40 8.3 Critical accounting estimates and assumptions Impact of new accounting standards 42 8.4 Internal controls over financial reporting Section 9 – Risk management 44 9.1 Risk management principles and responsibilities 46 9.2 Operational risk management 47 9.3 Corporate governance and compliance 47 9.4 Industry standards Section 10 – Other matters 48 10.1 Related party transactions 48 10.2 Cautionary note regarding forward-looking statements Section 11 – Additional information I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 13 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 14 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) Performance highlights Notes: All references to “direct premiums written” in this MD&A exclude pools, unless otherwise noted. All references to “investment portfolio” refer to the company’s portfolio of invested assets. TABLE 1 Written insured risks (thousands) Direct premiums written (excluding pools) Net underwriting income Combined ratio Net (losses) gains on invested assets and other gains (table 8) Effective income tax rate Net income EPS – basic and diluted (dollars) ROE for the last 12 months Book value per share Fourth quarter 2007 Q4 2007 Q4 2006 Change 1,056.7 961.3 47.5 1,051.1 955.6 62.3 95.3% 93.6% (3.3) 27.8% 95.8 0.77 15.4% 25.48 15.3 35.4% 109.4 0.82 20.8% 25.58 0.5% 0.6% (23.8)% 1.7 pts (121.6)% (7.6) pts (12.4)% (6.1)% (5.4) pts (0.4)% 2006 Change 2007 4,679.9 4,108.6 208.9 4,565.1 3,993.6 403.8 94.7% 89.4% 73.6 24.3% 508.3 4.01 193.5 30.9% 658.1 4.92 2.5% 2.9% (48.3)% 5.3 pts (62.0)% (6.6) pts (22.8)% (18.5)% Underwriting income was $47.5 million in the fourth quarter, down by $14.8 million compared to the same period in 2006. Excluding the impact of a $20.7 million market yield adjustment to claims liabilities, underwriting income increased year-over-year. Solid operating performance reflected higher personal property and commercial non-auto underwriting results versus the fourth quarter last year. Personal auto underwriting income decreased due to higher severity and frequency of claims. Direct premiums written were relatively flat as personal lines growth was offset by a decrease in premiums in commercial lines, reflecting a shift in the portfolio mix toward smaller accounts that are less price-sensitive. In the fourth quarter, written premium rates in personal lines rose slightly for the first time since 2003. Rates are being adjusted upward in certain geographic regions in both personal auto and personal property to take into account cost inflation. Net income decreased in the fourth quarter due to debt and equity asset impairments which led to a small net loss on invested assets compared to a gain in the fourth quarter of 2006 (shown in table 8). The impact of the market yield adjustment on underwriting income was offset by gains on held-for-trading invested assets, resulting in a minimal net impact to net income. 14 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 15 SECTION 1 – ING Canada 1.1 Overview of the business ING Canada is the largest provider of property and casualty (“P&C”) insurance in Canada offering automobile, property and liability insurance to more than four million individuals and small- and medium-sized businesses across Canada. Overall, the company has an approximate 11.0% market share and is the leading private sector P&C insurer in Québec, Alberta and Nova Scotia, and the second largest in Ontario. ING Canada distributes insurance through brokers under the ING Insurance and Grey Power brands, and direct-to-consumers through belairdirect. The investment management subsidiary manages the invested assets of ING Canada Inc. and its insurance subsidiaries. Personal insurance ING Canada is the largest personal auto and property insurer in Canada. The market as a whole is very fragmented – the top five P&C insurers represent less than 40.0% of annual premiums in Canada. In automobile, the company is 30.0% larger than the second largest insurer and 58.0% larger than the third, based on the most recently reported industry data. In property, the gap is even larger – ING Canada is approximately 45.0% larger than the second largest insurer and 80.0% larger than the number three insurer in the market. Though the company holds the number one position in both segments of personal insurance, its estimated market share is only 14.0% in automobile and 15.0% in property, demonstrating the potential to continue to grow this segment of the business. Over the last 10 years, ING Canada has sustained a superior claims ratio gap of 600 basis points below the industry average in automobile insurance. In personal property, the company incurred higher claims due to heavier seasonal storm activity than was expected and consequently has underperformed the industry in terms of claims ratio. The company has initiated a focused strategy to better manage water loss exposures by: 1) adjusting pricing models and insured amounts to reflect current reconstruction cost factors; and, 2) taking advantage of claims management expertise to reduce claims costs. These actions should enable the company to gain a claims ratio advantage in that segment in the future. Commercial insurance ING Canada is also one of the largest players in commercial insurance with a significant share of the small- to medium-size commercial segment, which makes up approximately 90.0% of the company’s commercial premiums. Over the last 10 years, the company’s claims ratio in commercial lines has outperformed the industry average claims ratio by more than 500 basis points annually and the positive gap has been widening in more recent years. Though commercial insurance can be subject to significant market pricing volatility, mainly due to excess capital in the industry, ING Canada’s strategy is to remain disciplined in pricing and grow by targeting sub-segments of the market that are priced attractively through the P&C cycle. Investment management ING Canada actively manages its portfolio of invested assets to generate superior after-tax returns while balancing capital preservation and risk. The portfolio strategy is more heavily concentrated in equities compared to the average Canadian insurer to maximize dividend income. ING Canada’s return on invested assets was 170 basis points higher than its benchmark of Canadian P&C insurers over the last five years of reported industry data ending in 2006. See section 7.2 for more information on the quality, asset mix, and performance of the company’s portfolio of invested assets. 2007 direct premiums written by business line (excluding pools) (%) 2007 direct premiums written by distribution channel (%) 2007 investment asset mix1 (%) ($ millions) Personal auto 50% $ 2,057.7 Personal property 22% $ 904.4 Commercial auto 8% $ 321.2 Commercial non-auto 20% $ 825.3 ($ millions) Brokers 77% $ 3,156.3 Affiliated distribution network brokerages 12% $ 499.0 belairdirect 11% $ 453.3 ($ millions) Common shares 24% $ 1,709.5 Fixed income 53% $ 3,867.8 Preferred shares 20% $ 1,430.8 Other 3% $ 229.7 1 Fair value, as at December 31, 2007 The company has a zero cash policy I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 15 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 16 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) 1.2 Critical capabilities ING Canada has several critical capabilities which enable it to sustain its strong performance in the Canadian P&C industry. These critical capabilities are described in the table below. Significant scale advantage The key benefit of scale is a uniquely comprehensive database of customer and claims Underwriting discipline/ pricing sophistication information that allows the company to more accurately model the risk of each policy. The company also uses its scale to negotiate preferred terms with suppliers, priority service on repairs, quality guarantees on workmanship and lower material costs. Through underwriting and pricing expertise, the company is constantly refining and enhancing its proprietary risk scoring models. In addition, scale enables the company to identify market opportunities that haven’t been exploited by other insurers. The company’s objective is to establish pricing that 1) will continue to attract new business, 2) is fair for the customer; and, 3) is profitable. Expertise in claims management More than 95.0% of ING’s claims are handled in-house. By managing claims in-house, claims are settled faster and less expensively, and a more consistent service experience is created for the customer. In 2007, the company achieved a 95.0% customer claims satisfaction rate. Product innovation ING Canada is constantly developing new products to attract customers and retain existing business at renewal time. Product features such as Responsible Driver Guarantee are available to new customers as a premium policy feature, but are provided for free to customers of five or more years. The company also offers one Aeroplan Mile® for every $2 paid in premiums. In the commercial lines segment, ING has worked aggressively to expand its customer loss prevention services. With more than 40 loss prevention specialists, ING conducted more than 9,500 site visits in 2007 and more than 4,000 building appraisals. Proven acquisition strategy ING Canada has been the most active in the industry’s consolidation with 11 successful acquisitions in 19 years. ING’s strategy is three-fold: – acquire businesses that fit existing business lines – integrate those businesses into the company’s technology infrastructure – increase the profitability of the acquired book of business through underwriting expertise and the use of proprietary pricing models Solid investment returns ING’s investment strategy is to generate solid after-tax returns while preserving capital and diversifying risk. The company’s $7.2 billion portfolio is comprised primarily of Canadian securities, including high-quality fixed income securities as well as common shares of large- cap companies and preferred shares that pay dividends. Over the last five years, the company’s portfolio of invested assets generated a market yield of 5.1%. Diverse business portfolio The company benefits from diversity in its geographic mix, product mix and multi-channel distribution. The diversity of the portfolio provides some insulation from the cyclicality of the industry. Aeroplan® is a registered trademark of Aeroplan Limited Partnership. 16 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 17 1.3 Key performance indicators ING Canada’s key performance indicators are defined in the table below. The following key performance indicators are considered non-GAAP measures. Non-GAAP measures do not have any standardized meaning prescribed by GAAP and may not be comparable to similar measures used by other companies in the P&C industry. Growth Direct premiums written The total premiums from the primary insured in respect of insurance underwritten by an insurer during a specified period. Written insured risks The number of vehicles in automobile insurance, the number of premises in personal property insurance and the number of policies in commercial insurance (excluding commercial auto insurance). Profitability Net underwriting income The difference between net premiums earned and the sum of net claims incurred, commissions, premium taxes and general expenses. Market-based yield This yield is calculated using the interest and dividend income for the period excluding realized gains and losses divided by the average invested assets calculated monthly including cash equivalents but excluding cash balances. Performance and execution Claims ratio Claims incurred, net of reinsurance, during a defined period and expressed as a percentage of net premiums earned for the same period. Capital management Expense ratio Underwriting expenses including commissions, premium taxes and all general and administrative expenses, incurred in operating the business during a defined period and expressed as a percentage of net premiums earned for the same period. Components of the expense ratio (commissions, premium taxes and general expenses) are individual ratios expressed as a percentage of net premiums earned. Combined ratio The sum of the claims ratio and the expense ratio. A combined ratio below 100.0% indicates a profitable underwriting result. A combined ratio over 100.0% indicates an unprofitable result. Return on equity (“ROE”) Represents net income for the 12 months ended on the date indicated divided by the average shareholders’ equity over the same 12-month period. Net income and shareholders’ equity are determined in accordance with GAAP. The average shareholders’ equity is the mean of shareholders’ equity at the beginning and end of the period. Shareholders’ equity includes accumulated other comprehensive income (“AOCI”). The company compares its ROE against that of the industry, when available. Book value per share Represents the shareholders’ equity at the end of the year divided by the number of outstanding common shares at the same date. I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 17 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 18 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) SECTION 2 – Canadian property and casualty industry outlook Management expects that several key factors will affect the Canadian property and casualty insurance industry over the coming 12 months. Industry growth and underwriting income We expect underwriting ratios and industry premium growth to trend toward historical averages. Automobile insurance The automobile insurance product has been favourable over the last 36 months both from a consumer and a competitive point of view. The stable cost environment and the reforms adopted by various provinces have been effective at containing and stabilizing claims and making auto insurance products more affordable and available to consumers. Accident benefit and bodily injury claims have risen in Ontario. In addition, the $4,000 cap on pain and suffering awards on minor injuries in Alberta is being challenged. Industry participants will need to assess the potential impact on claims costs and premiums. These developments will likely lead to premium increases. Personal property insurance Increases in water-related property damages caused by seasonal storm activity as well as Commercial insurance construction cost inflation have contributed to higher claims ratios in the personal property segment. Construction cost inflation and rate activity could drive increases in industry premiums in the property segment. Commercial insurance continues to be competitive. Rates on large commercial accounts are under more pressure than small and medium commercial accounts. The company remains disciplined in pricing and underwriting and committed to superior service to brokers and commercial customers. Material and labour cost inflation could put pressure on underwriting margins in property lines. The company is working with brokers and customers to ensure that policies include sufficient coverage for current replacement costs of insured properties and adjusting pricing models accordingly, to reflect the elevated cost environment. As discussed in section 1.2, ING Canada has several significant critical capabilities that enable the company to produce superior returns to many other insurers in the industry. 18 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 19 SECTION 3 – Overview of consolidated performance 3.1 Financial results TABLE 2 (Key performance indicators are bolded in the table below) Written insured risks (thousands) Direct premiums written (including pools) Direct premiums written (excluding pools) Underwriting: Net premiums earned Net claims and general expenses (table 4) Net underwriting income Combined ratio Claims ratio Expense ratio Interest and dividend income, net of expenses (table 6) Market-based yield Net (losses) gains on invested assets and other gains (table 8) Corporate and distribution (table 14) Income before income taxes Income taxes Effective income tax rate Net income EPS – basic and diluted (dollars) ROE for the last 12 months Book value per share (dollars) 3.2 Explanation of financial results Fourth quarter 2007 Q4 2007 Q4 2006 Change 1,056.7 959.7 961.3 1,004.7 957.2 47.5 95.3% 66.9% 28.4% 86.5 5.1% (3.3) 1.9 132.6 36.8 27.8% 95.8 0.77 15.4% 25.48 1,051.1 963.6 955.6 979.6 917.3 62.3 93.6% 64.2% 29.4% 87.1 4.8% 15.3 4.5 169.2 59.8 35.4% 109.4 0.82 20.8% 25.58 0.5% (0.4)% 0.6% 2.6% 4.3% (23.8)% 1.7 pts 2.7 pts (1.0) pts (0.7)% 0.3 pts (121.6)% (57.8)% (21.6)% (38.5)% (7.6) pts (12.4)% (6.1)% (5.4) pts (0.4)% 2007 4,679.9 4,100.0 4,108.6 3,932.0 3,723.1 208.9 94.7% 65.7% 29.0% 344.8 5.1% 73.6 44.3 671.6 163.3 24.3% 508.3 4.01 2006 Change 4,565.1 3,990.4 3,993.6 3,826.6 3,422.8 403.8 89.4% 59.1% 30.3% 321.3 4.8% 193.5 33.4 952.0 293.9 30.9% 658.1 4.92 2.5% 2.7% 2.9% 2.8% 8.8% (48.3)% 5.3 pts 6.6 pts (1.3) pts 7.3% 0.3 pts (62.0)% 32.6% (29.5)% (44.4)% (6.6) pts (22.8)% (18.5)% Direct premiums written were up slightly as personal lines growth of 2.3% was partly offset by a 3.1% decrease in premiums in commercial lines. Lower premiums in commercial lines reflect our pricing discipline which led to a shift in the portfolio mix toward smaller accounts, as well as moderate rate decreases. Underwriting income was down by $14.8 million in the fourth quarter, but increased year-over-year excluding the impact of a $20.7 million market yield adjustment to net claims liabilities. The impact of the market yield adjustment on underwriting income was offset by gains on held-for-trading invested assets, which resulted in a minimal net impact to net income. See section 7.3, Claims liabilities. Written insured risks (thousands) Direct premiums written (excluding pools) ($ millions) Net income ($ millions) 1,012.6 1,051.1 1,056.7 924.8 1,200 1,000 800 600 400 200 0 $1,000 $870.0 $913.6 $955.6 $961.3 $800 $600 $400 $200 $0 $200 $150 $100 $50 $0 Q4 2004 Q4 2005 Q4 2006 Q4 2007 Q4 2004 Q4 2005 Q4 2006 Q4 2007 Q4 2004 Q4 2005 Q4 2006 $25.3 $147.8 $50.9 $146.0 $7.6 $101.8 $102.8 ($7.0) Q4 2007 Net gains on invested assets and other gains Net operating income I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 19 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 20 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) Increases in underwriting income in personal property and commercial non-auto offset lower underwriting income in auto lines. The main factors that contributed to improved results in personal property and commercial non-auto included more favourable prior year claims development and lower catastrophe claims in personal property. In personal auto, underwriting income decreased due to higher claims severity and frequency. Net income decreased in the fourth quarter due to debt and equity asset impairments which led to a small net loss on invested assets compared to a gain in the fourth quarter of 2006. Equity and debt impairments were partly offset by gains on derivatives and embedded derivatives (see table 8). The following table reflects major changes in income before income taxes. TABLE 3 As reported in 2006 Higher (lower) favourable prior year claims development Current accident year: Lower losses from catastrophes Lower results from Facility Association Lower current accident year underwriting income Change in net underwriting income Lower net gains on invested assets and other gains (Lower) higher interest and dividend income, net of expenses Corporate and distribution As reported in 2007 Full year 2007 Q4 2007 169.2 21.1 16.8 (14.7) (38.0) (14.8) (18.6) (0.6) (2.6) 132.6 2007 952.0 (54.0) 18.1 (17.1) (141.4) (195.0) (120.0) 23.5 11.1 671.6 Direct premiums written rose 2.9% due to increases in written insured risks and amounts insured in personal lines. In commercial lines, lower direct premiums written reflect continued pricing discipline which led to a shift in the portfolio toward smaller accounts and slower growth in written insured risks. Net income was down by 22.8% due to a combination of lower underwriting income and a decrease in net gains on invested assets, compared to relatively high net gains in 2006. Net gains on invested assets were $119.9 million lower in 2007 due to a combination of investment impairments and lower realized gains on invested assets. A lower effective tax rate, higher interest and dividend income and an increase in corporate and distribution income positively contributed to net income in 2007. The effective income tax rate decreased mainly because non- taxable dividend income was higher relative to underwriting income. Higher current and prior year claims in personal auto were the largest factors that caused the decrease in underwriting income in 2007. Increases in current year property claims also contributed significantly to the underwriting shortfall versus 2006, partly offset by lower catastrophe claims in 2007. In addition, underwriting income was positively impacted by a $19.8 million market yield adjustment. Return on equity Return on equity (“ROE”) for the 12-month period ending December 31, 2007 was 15.4% compared to 20.8% in 2006. Book value per share The book value per share was flat in the fourth quarter reflecting the impact of the share buyback in early 2007 which reduced share capital and retained earnings. Written insured risks (thousands) Direct premiums written (excluding pools) ($ millions) Net income ($ millions) 4,417.9 4,565.1 4,679.9 3,857.6 2004 2005 2006 2007 $ 5,000 $ 4,000 $ 3,000 $ 2,000 $ 1,000 $ 0 $3,905.9 $3,993.6 $4,108.6 $3,501.4 2004 2005 2006 2007 $ 800 $ 600 $ 400 $ 200 $ 0 $169.5 $612.3 $91.9 $532.3 $127.5 $530.5 $38.3 $470.0 2004 2005 2006 2007 Net gains on invested assets and other gains Net operating income 5,000 4,000 3,000 2,000 1,000 0 20 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 21 3.3 Recent events Alberta cap on pain and suffering awards on minor injuries In 2004, the Government of Alberta introduced auto insurance reforms to make insurance more affordable and accessible for all Albertans. The reforms included numerous initiatives such as the introduction of a premium grid, premium rollbacks, a diagnostic and treatment process designed to provide injured individuals prompt diagnosis and treatment and Minor Injury Regulation (“MIR”) that capped awards for pain and suffering for minor injuries at $4,000. On February 8, 2008, a decision was rendered by the Court of Queen’s bench in Alberta which basically results in the lifting of the $4,000 cap on pain and suffering awards for minor injuries in the province. The decision has been appealed by the Alberta government but uncertainty remains over the ultimate outcome of the court’s decision. The December 31, 2007 financial statements include a provision for this item. Management continues to assess the potential impact on claims costs and premiums and as more information is available, will react appropriately. If the changing situation results in a reassessment of the provision, any changes would be recorded in future quarters. ING Canada normal course issuer bid On February 19, 2008, the Board of Directors approved a recommendation by management to proceed with a normal course issuer bid to purchase for cancellation during the next 12 months up to 6,223,638 common shares, representing 5.0% of the currently outstanding common shares of the company. The actual number of common shares which may be purchased and the timing of any such purchases will be determined by ING Canada. ING Groep, ING Canada’s majority shareholder, has advised ING Canada of its intention to participate on a proportionate basis in the program to maintain its ownership in the company at 70.0%. Purchases from minority shareholders will be made on the open market through the facilities of the Toronto Stock Exchange at market prices and in accordance with the rules of the TSX applicable to normal course issuer bids. The company’s strong capital base enables it to return capital to shareholders through a share buyback while retaining sufficient financial resources to pursue its acquisition strategy. The normal course issuer bid constitutes a flexible way of distributing some excess capital to shareholders while increasing shareholder value over the long term. Refer to the news release posted on the company’s web site at www.ingcanada.com for more information on the normal course issuer bid. I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 21 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 22 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) 3.4 Underwriting Written insured risks The number of written insured risks grew 0.5% during the fourth quarter and by 2.5% in 2007, driven by growth in personal lines. The rate of unit growth in personal lines slowed in the fourth quarter reflecting the near-term effect of premium rate increases in certain geographic regions in late 2007. In commercial lines, the number of insured risks was up slightly in the fourth quarter and flat in 2007 overall, reflecting pricing discipline in a highly competitive marketplace. Direct premiums written (excluding pools) Direct premiums written increased 0.6% in the fourth quarter driven by higher premiums in personal lines. Overall in 2007, direct written premiums rose 2.9% reflecting increases in written insured risks and average amounts insured in personal lines. In commercial lines, direct premiums written decreased 3.1% in the fourth quarter and also for the full year, compared to the same periods in 2006. TABLE 4 Net claims: (Favourable) prior year claims development Current year catastrophes Current year claims Total Commissions, net Premium taxes, net General expenses, net Total Combined ratio Q4 2007 Q4 2006 Change 2007 2006 Change (45.4) 9.7 707.4 671.7 146.3 35.0 104.2 957.2 (24.3) 26.4 627.2 629.3 154.7 33.2 100.1 917.3 86.8% (63.3)% 12.8% 6.7% (5.4)% 5.4% 4.1% 4.3% (115.9) 41.1 2,659.0 2,584.2 583.1 136.9 418.9 (169.9) 59.2 2,371.9 2,261.2 611.7 132.3 417.6 3,723.1 3,422.8 (31.8)% (30.6)% 12.1% 14.3% (4.7)% 3.5% 0.3% 8.8% 95.3% 93.6% 1.7 pts 94.7% 89.4% 5.3 pts Prior year claims development Favourable prior year claims development increased by $21.1 million in the fourth quarter. For the full year, favourable prior year claims development decreased by $54.0 million compared to 2006. The decrease in 2007 was primarily due to higher accident benefit and bodily injury claims in personal and commercial auto in Ontario. For the fourth quarter, the market yield adjustment had a $17.1 million negative impact on prior year claims development and $3.6 million on current accident year results for a total of $20.7 million. For the year, the market yield adjustment had a $13.6 million positive impact on prior year claims development. See section 7.3, Claims liabilities. The following table shows the annualized rate of favourable prior year claims development by quarter. TABLE 5 (Annualized rate) Favourable prior year claims development as a % of opening reserves Catastrophes 2007 2006 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 5.1% 2.3% 4.2% 1.4% 2.8% 7.9% 4.5% 4.2% Catastrophe claims were down by $16.7 million and $18.1 million in the fourth quarter and in 2007, respectively, compared to the same periods last year. Rain and hail in Western Canada in the spring and summer were the primary causes of catastrophe claims in 2007. Catastrophe claims are defined as a single event resulting in $5.0 million or more in aggregate claims. Current accident year claims Current accident year claims were up by $80.2 million in the fourth quarter and $287.1 million for the full year mainly due to higher auto and property claims severity in both periods. Refer to sections 4 and 5 for more detailed information on current accident year claims. 22 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 23 Commissions Variable commissions were down in the fourth quarter and for the full year of 2007 due to lower underwriting results. Industry pools Industry pools consist of the “residual market” as well as risk-sharing pools (“RSP”) in Alberta, Ontario, Québec, New Brunswick and Nova Scotia. These pools are managed by the Facility Association except the Québec RSP. In the fourth quarter and for the full year of 2007, the net effect of transfers in and out of these pools resulted in lower year-over-year underwriting income by $3.8 million and $6.5 million, respectively. 3.5 Interest and dividend income, net of expenses TABLE 6 Interest income Dividend income Interest and dividend income, before expenses Expenses Interest and dividend income, net of expenses Interest and dividend income Q4 2007 Q4 2006 Change 50.9 40.4 91.3 (4.8) 86.5 52.1 39.2 91.3 (4.2) 87.1 (2.3)% 3.1% – 14.3% (0.7)% 2007 197.7 166.5 364.2 (19.4) 344.8 2006 195.4 147.0 342.4 (21.1) 321.3 Change 1.2% 13.3% 6.4% (8.1)% 7.3% Interest and dividend income decreased slightly in the fourth quarter but increased overall in 2007 reflecting an increase in invested assets and higher yields. The company introduced a zero cash policy in early 2007, increasing its investments in fixed income securities. Market-based yield The market-based yield is a non-GAAP measure that represents the total interest and dividend income (before expenses) divided by the average fair values of equity and debt securities held during the reporting period. The market-based yield was 5.1% in the fourth quarter compared to 4.8% from the same quarter of last year. TABLE 7 Percentage (%) Market-based yield Market-based yield (%) 5 4 3 2 1 0 4.9 4.7 4.8 5.1 2004 2005 2006 2007 2007 Q4 5.1 Q3 5.1 Q2 5.1 Q1 5.0 I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 23 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 24 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) 3.6 Net (losses) gains on invested assets and other gains TABLE 8 Debt securities Realized gains (losses) Unrealized gains (losses) on held-for-trading debt securities Impairments Gains (losses) on derivatives Net gains (losses) on debt securities Equity securities Realized gains Unrealized losses on held-for-trading equity securities Impairments Gains (losses) on derivatives Gains on embedded derivatives Net gains (losses) on equity securities Other Total gains (losses) before income taxes Total gains (losses) after income taxes Fourth quarter and full year 2007 Q4 2007 Q4 2006 Change 2007 2006 Change 0.9 17.7 (8.1) (8.0) 2.5 7.8 (11.6) (34.7) 14.2 19.6 (4.7) (1.1) (3.3) (7.0) 6.8 – – (1.3) 5.5 29.1 – (7.0) (18.6) – 3.5 6.3 15.3 7.6 (86.8)% (16.5) n/a n/a 515.4% (54.5)% (6.4) (37.3) (4.0) (64.2) 23.8 – – 2.3 26.1 (169.3)% n/a n/a (273.9)% (346.0)% (73.2)% 151.9 193.4 (21.5)% n/a 395.7% (176.3)% n/a (234.3)% (117.5)% (121.6)% (192.1)% (13.7) (47.7) 11.5 38.1 140.1 (2.3) 73.6 38.3 – (20.4) (15.8) – 157.2 10.2 193.5 127.6 n/a 133.8% (172.8)% n/a (10.9)% (122.5)% (62.0)% (70.0)% In the fourth quarter, the company recorded a small pre-tax loss on invested assets due to asset impairments which were partly offset by gains on derivatives and embedded derivatives. These factors are described in more detail below. Capital notes and total return swaps associated with SIVs In the fourth quarter, the company incurred losses of $6.1 million in leveraged capital notes and $3.9 million in total return swaps associated with specific asset-backed securities (structured investment vehicles, or SIVs). The company incurred $49.8 million in losses associated with these SIVs during the year, including $34.0 million in capital notes and $15.8 million in total return swaps. As of the end of the year, the company had a remaining total SIV exposure of $19.8 million. Common and preferred shares The company recorded in the fourth quarter of 2007, impairments of $20.0 million on common shares and $14.7 million on preferred shares. The impairments were related to factors specific to certain securities as well as the large scale impact of the credit market events. Management generally impairs a security if the market value is unlikely to recover in the near- to mid-term future based on an assessment of information available at the time. Furthermore, common shares are generally impaired when the security is in a significant unrealized loss position for a period exceeding six months. Preferred shares make up 19.8% of the company’s portfolio of invested assets as part of its objective to maximize after-tax returns while balancing risk and capital preservation. The preferred shares in the portfolio are mainly stable, large-cap Canadian securities that pay dividends, which are generally deductible in the calculation of taxable income. The value of the company’s preferred share portfolio generally declined under current market conditions. As a result, some preferred shares were impaired through the company’s asset impairment process, described above. The company generally holds the preferred shares for the long term or until maturity, so fluctuations in the market value of preferred shares have little or no impact on the economic value of the assets as long as it continues to receive dividends from the issuers. Overall in 2007, the company recorded $47.7 million in impairments related to common and preferred shares, most of which occurred in the last half of the year for the reasons noted above. 24 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 25 Gains on derivatives and embedded derivatives The company also recorded gains on derivatives and call options embedded in perpetual preferred shares. The gains on embedded derivatives were associated with the decline in market values of the preferred shares. The gains on embedded derivatives flow through the income statement while changes in the fair values of preferred shares flow through other comprehensive income. Under accounting rules introduced in 2007, the value of preferred shares and embedded derivatives (if any) are recorded separately. For example, call options embedded in preferred shares are recorded as liabilities and the preferred shares are recorded as assets. If the market value of a preferred share declines, the call option is less likely to be exercised by the issuer. The liability associated with the call option is eliminated and an offsetting gain is recorded. In 2007, the value of certain of the company’s callable preferred shares declined in general and a gain was recorded for the embedded call options. For more information see section 8.4, Impact of new accounting standards introduced on January 1, 2007 as well as section 8.3, Critical accounting estimates and assumptions. 3.7 Net operating income TABLE 9 Net income Less: Net (losses) gains on invested assets and other gains, after income taxes (table 8) Net operating income Average outstanding shares (millions) Net operating income per share (dollars) Q4 2007 Q4 2006 Change 95.8 (7.0) 102.8 124.5 0.83 109.4 7.6 101.8 133.7 0.76 (12.4)% (192.1)% 1.0% (6.9)% 9.2% 2007 508.3 38.3 470.0 126.7 2006 658.1 127.6 530.5 133.7 3.71 3.97 Change (22.8)% (70.0)% (11.4)% (5.2)% (6.5)% Net operating income and net operating income per share are non-GAAP measures. Net operating income is equal to net income less net gains on invested assets and other gains, after tax. Net operating income per share is equal to net operating income for the period divided by the average outstanding number of shares for the same period. These measures may not be comparable to similar measures used by other companies; however, they are commonly used by investors to assess the company’s performance. Other comprehensive income Other comprehensive income (“OCI”) was introduced with accounting standards which became effective in January 2007. OCI includes the changes in fair values of invested assets classified as available for sale. Available for sale assets sold during the period are reflected in income and are no longer included in OCI. Unrealized gains on available for sale assets are tax-affected. Unrealized losses on available for sale securities and dispositions of available for sale securities resulted in negative OCI of $227.4 million in 2007. Lower market values of the company’s fixed income assets, some of which are classified as available for sale, reflect less favourable bond market conditions in 2007. 3.8 Selected quarterly information TABLE 10 Written insured risks (thousands) Direct premiums written (excluding pools) Total revenues Net underwriting income Net income Combined ratio (%) EPS-basic/diluted (dollars) (Favourable) prior year claims development (45.4) (20.7) (37.6) (12.2) 2007 2006 Q4 Q3 Q2 1,056.7 961.3 1,273.1 1,091.2 1,399.7 1,209.8 Q1 950.4 846.3 1,096.8 1,091.3 1,152.2 1,099.6 1,095.8 47.5 95.8 95.3 28.7 92.0 97.1 92.3 194.3 90.6 40.3 126.2 95.8 0.77 0.74 1.56 0.95 Q4 Q3 Q2 Q1 1,051.1 955.6 1,242.9 1,059.1 1,080.2 1,356.1 1,166.4 914.9 812.5 1,096.7 1,133.8 62.3 109.4 93.6 0.82 (24.3) 95.9 156.8 89.9 1.17 (69.1) 165.6 205.9 82.7 79.9 185.9 91.5 1.54 1.39 (39.5) (37.0) I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 25 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 26 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) 3.9 Selected annual information TABLE 11 Total revenue Net underwriting income Net income EPS – basic and diluted (dollars) Annual dividends per common share Invested assets Total assets Debt outstanding Total shareholders’ equity 2007 2006 2005 4,439.9 4,406.4 4,446.1 208.9 508.3 4.01 1.08 7,237.8 10,389.7 – 403.8 658.1 4.92 1.00 7,241.9 10,377.3 – 3,172.1 3,420.8 537.7 781.8 5.85 0.65 6,721.0 9,926.5 127.0 2,892.6 Financial performance between 2007 and 2006 is analyzed in detail in this document. In 2005, net income was higher than in 2006 due to the following factors (1) stronger underwriting income, particularly in personal automobile (2) more favourable prior year claims development; and, (3) robust results from the company’s investment portfolio. ING Canada has two segments: 1) P&C insurance; and, 2) Corporate and distribution. P&C insurance is divided into two lines of business, personal and commercial lines. Corporate and distribution includes income from investments in brokerages as well as other corporate items. SECTION 4 – Personal lines 4.1 Financial results TABLE 12 Written insured risks (thousands) Automobile Property Total Direct premiums written (excluding pools) Automobile Property Total Net premiums earned Automobile Property Total Net underwriting income (loss) Automobile Property Total Ratios Claims ratio Commissions ratio Premium taxes ratio General expenses ratio Combined ratio 26 Q4 2007 Q4 2006 Change 2007 2006 Change 541.5 394.6 936.1 453.1 215.3 668.4 515.2 217.6 732.8 9.1 3.7 12.8 71.7% 15.0% 3.4% 8.2% 98.3% 541.5 390.4 931.9 449.6 203.6 653.2 495.7 203.4 699.1 60.9 (18.7) 42.2 66.9% 16.1% 3.3% 7.7% 94.0% – 1.1% 0.5% 0.8% 5.7% 2.3% 3.9% 7.0% 4.8% (85.1)% (119.8)% (69.7)% 4.8 pts (1.1) pts 0.1 pts 0.5 pts 4.3 pts 2,514.4 1,676.1 4,190.5 2,057.7 904.4 2,962.1 2,008.0 837.0 2,845.0 123.1 (17.8) 105.3 69.0% 15.0% 3.4% 8.9% 96.3% 2,440.1 1,637.5 4,077.6 1,969.2 841.5 2,810.7 1,911.2 785.4 2,696.6 242.5 (0.3) 242.2 62.5% 16.3% 3.4% 8.9% 91.1% 3.0% 2.4% 2.8% 4.5% 7.5% 5.4% 5.1% 6.6% 5.5% (49.2)% n/a (56.5)% 6.5 pts (1.3) pts – – 5.2 pts 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 27 4.2 Explanation of financial results Fourth quarter 2007 Direct premiums written grew by 2.3% in personal lines, driven by higher average amounts insured. Direct written premium rates in personal lines also increased slightly for the first time since 2003. In personal auto, direct premiums written grew by 0.8% reflecting higher average amounts insured. Overall, direct written premium rates in personal auto were flat but increased in Ontario. Underwriting income in personal auto decreased year-over-year due to higher severity and frequency of current year claims. In personal property, direct premiums written were up 5.7%, reflecting higher insured amounts and a 1.1% increase in written insured risks. Underwriting income in personal property increased due to lower catastrophe claims and more favourable prior year claims development. Current year claims in personal property were up moderately, caused by an increase in severity. Building cost inflation factors, such as material costs and labour rates, have put pressure on underwriting margins in 2007, particularly in Western Canada. Full year 2007 Direct premiums written rose 5.4% in personal lines, driven by a 2.8% increase in the number of written insured risks and an increase in average amounts insured. In personal property, insured amounts are increasing to reflect higher reconstruction costs, particularly in Western Canada. The company’s pricing models are also being adjusted for regions that are most susceptible to seasonal storm activity and sewer back-up. Underwriting income declined in 2007 due to a combination of higher current and prior year claims in personal auto, as well as an increase in personal property claims. As mentioned in the fourth quarter commentary, increases in both frequency and severity in personal auto contributed to a decline in underwriting results versus 2006. Increases in seasonal rain, wind and hail storms in certain zones, cost inflation and some larger losses caused a meaningful increase in personal property claims severity in 2007. Overall, frequency of claims in personal property decreased. Personal lines – written insured risks (thousands) Personal lines – direct premiums written (excluding pools) ($ millions) Personal lines – combined ratio (%) 5,000 4,000 3,000 2,000 1,000 0 1,591.5 1,637.4 1,676.1 2,336.0 2,440.1 2,514.4 1,437.3 1,959.8 2004 2005 2006 2007 Personal auto Personal property $3,000 $2,500 $2,000 $700.9 $1,500 $1,638.3 $779.9 $841.5 $1,877.2 $1,969.2 $904.4 $2,057.7 $1,000 $500 $0 2004 2005 2006 2007 Personal auto Personal property 120 100 80 60 40 20 0 92.5 82.9 78.8 104.0 100.0 87.3 102.1 93.9 2004 2005 2006 2007 Personal auto Personal property I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 27 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 28 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) Q4 2007 Q4 2006 Change 2007 2006 Change 61.8 57.4 119.2 81.9 220.6 302.5 82.2 198.3 280.5 11.4 8.7 20.1 62.8 57.7 120.5 81.7 211.3 293.0 80.7 191.1 271.8 (1.8) 36.6 34.8 53.9% 20.2% 3.6% 9.5% 87.2% 1.6% 0.5% 1.1% (0.2)% (4.2)% (3.1)% (1.8)% (3.6)% (3.1)% 255.8 233.5 489.3 321.2 825.3 253.6 233.9 487.5 327.5 855.5 1,146.5 1,183.0 320.2 766.9 326.8 803.1 1,087.1 1,129.9 (115.8)% 320.7% 73.1% 22.0 81.4 103.4 57.7% 21.0% 3.5% 10.6% 92.8% (3.8) pts (0.8) pts 0.1 pts (1.1) pts (5.6) pts 57.2% 19.8% 3.6% 9.9% 90.5% 43.0 118.7 161.7 51.0% 20.9% 3.6% 10.2% 85.7% 0.9% (0.2)% 0.4% (1.9)% (3.5)% (3.1)% (2.0)% (4.5)% (3.8)% (48.8)% (31.4)% (36.1)% 6.2 pts (1.1) pts – (0.3) pts 4.8 pts SECTION 5 – Commercial lines 5.1 Financial results TABLE 13 Written insured risks (thousands) Automobile Non-auto Total Direct premiums written (excluding pools) Automobile Non-auto Total Net premiums earned Automobile Non-auto Total Net underwriting income (loss) Automobile Non-auto Total Ratios Claims ratio Commissions ratio Premium taxes ratio General expenses ratio Combined ratio 28 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 29 5.2 Explanation of financial results Fourth quarter 2007 Direct premiums written decreased by 3.1% in commercial lines. The decline reflects a shift in the mix of the portfolio to smaller commercial accounts with lower annual premiums and moderate rate reductions. Written insured risks were up modestly, indicating the competitiveness of the commercial market in 2007. The company’s commercial business is focused on small- to medium-sized accounts which are less price- sensitive, providing some insulation in a more aggressive pricing environment. Underwriting income and the combined ratio in commercial lines improved markedly in the fourth quarter due to more favourable prior year claims development and slightly lower current year claims. Full year 2007 Direct premiums written were down 3.1% in 2007 primarily due to price competition in the marketplace, moderate rate decreases and a change in portfolio mix toward smaller accounts, referred to in the fourth quarter discussion. The number of written insured risks increased slightly. Underwriting income decreased significantly during the year, principally due to an increase in current year claims severity in commercial non-auto caused by weather-related events and an increase in large losses. In commercial auto, underwriting income declined due to less favourable prior year claims development in 2007. Current year claims only increased slightly in commercial auto. Commercial lines – written insured risks (thousands) Commercial lines – direct premiums written ($ millions) Commercial lines – combined ratio (%) 500 400 300 200 100 0 228.7 231.8 236.4 233.9 233.5 254.4 253.6 255.8 2004 2005 2006 2007 Commercial auto Commercial non-auto $1,500 $1,200 $900 $600 $300 $0 $859.7 $917.6 $855.4 $825.3 $302.5 $331.2 $327.5 $321.2 2004 2005 2006 2007 Commercial auto Commercial non-auto 100 80 60 40 20 0 89.6 81.2 87.0 86.4 86.9 85.2 93.1 89.4 2004 2005 2006 2007 Commercial auto Commercial non-auto I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 29 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 30 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) SECTION 6 – Corporate and distribution 6.1 Financial results Our corporate and distribution segment primarily includes the results of the company’s brokerage operations (Canada Brokerlink, Grey Power and Equisure) and other activities. TABLE 14 Distribution income Distribution expenses Distribution earnings Other income (loss), net Interest on debt Income before income taxes Q4 2007 Q4 2006 Change 26.9 21.4 5.5 (3.6) – 1.9 25.0 19.7 5.3 (0.8) – 4.5 7.6% 8.6% 3.8% 350.0% n/a (57.8)% 2007 102.9 85.3 17.6 26.7 – 44.3 2006 100.0 71.0 29.0 9.7 5.3 33.4 Change 2.9% 20.1% (39.3)% 175.3% n/m 32.6% 6.2 Explanation of financial results Other income in 2007 included a reduction to a provision established for a prior year divestiture that became redundant. The total reduction was $28.0 million in 2007, which was recorded in the first and second quarters. Corporate and distribution – income before income taxes ($ millions) $44.3 $33.4 $22.3 $4.3 2004 2005 2006 2007 $50 $40 $30 $20 $10 $0 30 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 31 SECTION 7 – Financial condition 7.1 Balance sheet highlights The table below shows the balance sheets as reported on December 31, 2006, January 1, 2007 (after adopting the new accounting standards) and December 31, 2007. All comparisons in this section are made to January 1, 2007 figures which were restated from December 31, 2006 in accordance with accounting standards adopted at the beginning of 2007. See section 8.4 for the impact of the adoption of the new accounting standards. TABLE 15 Cash and cash equivalents Invested assets Premiums receivables Accrued interest and dividend income Other receivables Deferred acquisition costs Reinsurance assets Other assets Income taxes receivable Future income tax asset Intangible assets and goodwill Total assets Claims liabilities Unearned premiums Other liabilities Income taxes payable Total liabilities Share capital Contributed surplus Retained earnings AOCI Total shareholders’ equity Total liabilities and shareholders’ equity Book value per share (dollars) Dec. 31, 2007 Jan. 1, 2007 Dec. 31, 2006 As at 8.1 7,237.8 1,440.8 46.2 264.8 379.6 273.5 280.1 168.4 68.7 221.7 126.0 7,503.9 1,366.9 51.1 282.8 372.8 290.1 246.0 54.1 55.5 228.4 126.0 7,241.9 1,366.9 51.1 282.8 372.8 288.1 246.0 54.1 119.2 228.4 10,389.7 10,577.6 10,377.3 3,989.0 2,333.5 862.6 32.5 7,217.6 1,101.9 97.2 2,091.3 (118.3) 3,172.1 3,841.4 2,264.1 922.5 24.0 7,052.0 1,183.9 93.5 2,139.1 109.1 3,525.6 3,823.5 2,264.1 844.9 24.0 6,956.5 1,183.9 93.5 2,143.4 – 3,420.8 10,389.7 10,577.6 10,377.3 25.48 26.40 25.58 Invested assets, including cash and cash equivalents, decreased by $384.0 million notwithstanding cash flows generated from operations of $620.3 million due to the share buyback of $501.2 million in the first quarter of 2007 and to the decline in the fair values by $310.6 million in 2007 compared to 2006 following the general decline in capital market conditions. This decline is reflected in the December 31, 2007 AOCI position. Premium receivables, deferred acquisition costs and unearned premiums are higher consistent with increases in direct written premiums. A portion of deferred acquisition costs related to prior acquisitions were reclassified to goodwill during the second quarter; comparative numbers have been adjusted accordingly. Income taxes receivable are higher due to the company’s invested assets unrealized losses in 2007, which are deductible on a fair value basis, compared to unrealized gains in 2006. Claims liabilities and unearned premiums are slightly higher when compared to last year due to a greater number of policies in force. Note 6 to the Audited Consolidated Financial Statements provides a reconciliation of the changes in claims liabilities and unearned premiums. I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 31 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 32 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) Other liabilities decreased when compared to January 1, 2007 mainly because of the decrease in the fair value of the derivatives embedded in the company’s preferred shares, which are now accounted for separately and presented with other liabilities according to the new accounting standards introduced in January 2007. Shareholders’ equity was reduced significantly as a result of the share buyback. The total cost of the purchase was $501.2 million, including expenses net of income taxes. An amount of $82.0 million was deducted from share capital and the remainder from retained earnings. 7.2 Portfolio of invested assets The company’s portfolio of invested assets is managed by ING Investment Management Inc. (“IIM”), which is a wholly owned subsidiary of ING Canada. Each insurance subsidiary’s assets are managed by IIM in accordance with the company’s investment policy. ING Canada has an investment policy that seeks to provide an attractive risk-return profile over the medium to long term. The investment policy takes into account the current and expected condition of capital markets, the historical return profiles of various asset classes and the variability of those returns over time, the availability of assets, diversification needs and benefits, regulatory capital required to support the various asset types, security ratings and other material variables likely to affect the overall performance of the company’s portfolio of invested assets. The overall risk profile of the portfolio is designed to balance the investment portfolio return needed to satisfy the company’s liabilities while optimizing the investment opportunities available in the marketplace. Management monitors and enforces compliance with the investment policy. Mix of investment portfolio TABLE 16 Cash and cash equivalents Short-term notes Fixed income securities Preferred shares Common shares Commercial mortgages1 Loans to brokers Equity investments As at December 31, 2007 As at December 31, 2006 Fair value (“FV”) % of FV FV % of FV 8.1 18.9 3,867.8 1,430.8 1,709.5 –– 188.2 22.6 0.1% 0.3% 53.4% 19.7% 23.6% 2.6% 0.3% 126.0 713.5 3,281.6 1,517.1 1,700.4 59.0 156.9 14.7 1.7% 9.4% 43.3% 20.0% 22.5% 0.8% 2.1% 0.2% Total invested assets and cash 7,245.9 100.0% 7,569.2 100.0% 1 In 2007, the commercial mortgages portfolio was sold and the proceeds were reinvested in other types of assets. The majority of the company’s portfolio is invested in mainly high quality Canadian securities that are actively traded. The fair value for most invested assets is based on quoted bid prices. In cases where an active market does not exist, the estimated fair values are based on recent transactions or current market prices for similar securities. In 2007, the amount of invested assets declined reflecting the cash and short-term notes used to buyback shares in the first quarter. Fixed income securities The company invests in highly-rated fixed income securities mainly including corporate bonds and government bonds, as well as asset-backed securities (“ABS”), Canadian residential mortgage-backed securities and private placements. The fixed income portfolio is mostly Canadian with 18.7% foreign content. The ABS portfolio includes credit card loans, auto finance loans and commercial mortgage-backed securities. In addition, the company owns a small portion of Canadian government-guaranteed residential mortgage-backed securities which make up less than 0.5% of the fixed income portfolio. The company did not have any direct investments in asset-backed commercial paper, collateralized debt obligations, hedge funds, monolines or U.S. mortgage loans as at the end of 2007. The company has a remaining SIV exposure of $19.8 million, including $10.7 million in capital notes and $9.1 million in total return swaps, which represents less than 0.3% of the company’s $7.2 billion investment portfolio. Common shares Common equity exposure is focused primarily on high dividend-paying Canadian equities. The company seeks enhanced returns by identifying and investing in shares that are likely to pay increased dividends or pay special dividends. Management undertakes intensive analysis of investment opportunities to identify special dividend candidates. Similar evaluations are conducted to assess securities most likely to increase dividends. In addition, the equity portfolios are also actively managed to achieve additional dividend payments to maximize dividend income throughout the year. 32 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 33 Preferred shares The company’s investment portfolio includes a large percentage of preferred shares to achieve its objective of maximizing dividend income, which is generally deductible in the calculation of taxable income. The preferred share portfolio is not actively managed and preferred shares are generally held until they are called. Consequently, the company’s results are impacted only when preferred shares are impaired, or when the shares are called or sold. The preferred share portfolio is 100.0% Canadian. Derivatives The company uses derivative financial instruments for hedging purposes and to modify the risk profile of the portfolio of invested assets as long as the resulting exposures are within investment policy guidelines. Cash and cash equivalents In the first half of 2007, management adopted a zero cash strategy under which cash and short-term notes are maintained at their minimum level and the excess assets are now invested in fixed income securities. Credit ratings As at December 31, 2007, the weighted average rating of the company’s fixed income portfolio was AA and the weighted average rating of its preferred share portfolio was P2 (ratings are by Standard & Poor’s (“S&P”) or Dominion Bond Rating Services). Approximately $36.8 million of securities with a rating below investment grade were included in the fixed income and preferred share portfolios at December 31, 2007, compared to $35.8 million as at December 31, 2006. Sector exposures The following table sets forth the company’s exposure to the largest industrial sectors. TABLE 17 Banks, insurance and diversified financial services Government Utilities Other Total invested assets Sector exposures (% of FV) Banks, insurance and diversified financial services Government Utilities Other 43.0% 42.8% 5.1% 9.1% As at December 31, 2007 As at December 31, 2006 FV % of FV FV % of FV 3,112.3 3,097.8 369.1 658.6 7,237.8 43.0% 42.8% 5.1% 9.1% 2,917.7 3,580.2 357.3 588.0 39.2% 48.1% 4.8% 7.9% 100.0% 7,443.2 100.0% The company has higher exposure to banks, insurance companies and diversified financial services companies than its benchmark of P&C insurers reflecting ING Canada’s strategy to maximize non-taxable dividend income through investments in preferred shares and active management of its common share portfolio. Though the company’s preferred share strategy continued to generate significant incremental dividend income in 2007, the widening of credit spreads late in the year resulted in a general decline in the value of the preferred share portfolio. I N G C A N A D A I N C . 2 0 0 7 A N N U A L R E P O R T 33 35167 ING 07 BACK.qxd:Layout 1 3/24/08 10:30 AM Page 34 Management’s Discussion and Analysis (CONT’D) (in millions of dollars, except as noted) Investment portfolio credit quality The following table includes the credit quality of the fixed income portfolio as at December 31, 2007 and 2006. TABLE 18 Fixed income securities AAA AA A BBB BB B

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