Upload
tmx-equicom
View
824
Download
5
Embed Size (px)
DESCRIPTION
2008 annual report for EGI Financial Holdings Inc. (TSX: EFH), a company that operates in the property and casualty insurance industry in Canada and the U.S.
Citation preview
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
Slow & steady wins the race.The tortoise and the hare – it’s a story we all know. And it’s a philosophy we embrace at EGI: slow and steady wins the race. We are
focused on one overriding objective: delivering consistent profitability. We have a disciplined operating model designed to support
that objective. This is evident in all areas of business, including our pricing, our service and our claims handling. We know our niche
markets exceptionally well, and we have proved we can consistently generate superior returns on equity in these markets by sticking
to our disciplined approach. Put simply, we will not chase new premiums at the expense of profit. And we believe this approach is the
right one to build market share and increase value for shareholders over the long term.
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
our core expertise 2009 growth strategies
personal lines division
63%of premiums
written in 2008
The Personal Lines division continues to focus on the underwriting of non-standard automobile insurance and motorcycle business, but has expanded into other specialty products in underserved markets.
Expand non-standard auto writings in ��Canadian jurisdictions where EGI earlier withdrew or restricted its premium writing (e.g. Prince Edward Island and Nova Scotia).
Continue to monitor the impact of ��government reforms in Ontario aimed at reducing fraudulent claims, which may allow EGI to increase its business activities in additional urban markets.
Continue to build the Company’s profitable ��personal and commercial auto lines of business in the province of Quebec.
Use EGI’s non-standard underwriting expertise ��to add new specialty personal lines insurance products such as coverage for motorcycles in Alberta, snowmobiles, all terrain vehicles, antique autos and recreational vehicles.
Continue to expand our distribution networks ��both by number of producers and share of their business.
niche products division
29%of premiums
written in 2008
Through its Niche Products division, EGI designs and underwrites specialized non-auto insurance programs, such as higher premium property, primary and excess liability, legal expense and accident and health insurance for a variety of businesses and consumers and extended warranty coverage for homes and consumer products.
Continue to broaden market awareness ��of EGI’s Niche Products division through proactive outreach to qualified brokers and other insurance product distributors.
Ensure that the division grows organically ��by continuing to provide unique expertise and superior service in response to all business inquiries.
Seek opportunities to grow through select ��acquisitions of books of business, distributors, administrators or an insurance company.
international division
8%of premiums
written in 2008
EGI formed the International division in 2008 to expand into the United States. Currently, this division is focused on personal lines business, predominantly non-standard automobile insurance.
Exit the third-party reinsurance market.��
Launch a new and/or acquire a suitable existing ��non-standard automobile insurance company.
Focus on select states and markets. ��
New company will serve as an entry point for ��EGI’s personal lines product offerings into the U.S. market.
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
EGI’s prudent approach brings steady, stable growth even in difficult markets.We believe steady, stable growth works. We don’t believe in taking imprudent risks, and this has served us well in the past – especially
in tough markets. So while we diversify our business, both geographically and by product line, we take a very measured and pragmatic
approach. We start with niche insurance lines we know inside and out. We do thorough research and we enter a market slowly.
When we see clear evidence that the business can produce sustainable profits, we invest further. And if something new doesn’t meet our
expectations, we are quick to change course. In recent years, we have broadened well beyond our core product line, successfully
expanding our Niche Products division. While our initial approach in the U.S. did not meet our expectations, we see significant
opportunity for our personal lines in this large and growing market.
us$36.9Bu.s. market for non-standard auto insurance, with the five largest states being california, texas, florida, new york and georgia
$800Mcanadian market for non-standard auto insurance
$4Bcanadian market for niche products
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
1st
with brokers.“Echelon General Insurance Company backs up their commitment to top quality service by going above and beyond my expectations as a brokerage owner. Echelon’s top notch service philosophy allows my brokers to provide the level of service that fosters an environment of increased competitiveness and ultimately results in maximum client retention. In comparison to the other providers that we use both standard and non standard, Echelon continues to outperform them resulting in you now being our first choice when we place business. The management and staff at Echelon are to be commended for a job well done!”
~ Mario Galluzzo, President Causeway General Insurance Brokers
EGI strives to provide optimum service to its policyholders and producers. We have created and implemented
written service standards in all departments interfacing with policyholders or producers. Staff members in these
departments are thoroughly trained in the delivery of quality service to achieve these standards. This service
commitment ensures our policyholders and producers continue to be served by knowledgeable employees in a
responsive manner. And it has paid off: we are consistently recognized by brokers as having superior service.
We strongly believe service is a competitive advantage, and as we expand the company we will ensure these
standards are consistently applied. This will help us achieve the best possible reputation among our peers and
realize our vision to be the pre-eminent writer of specialized, niche products in the Canadian market.
LETTER TO SHAREHOLDERS
In one of the most volatile and difficult years ever in global financial markets, our disciplined underwriting
philosophy and conservative investment strategy enabled us to generate profits and year-over-year growth in
2008. This is in sharp contrast to many other North American insurers, and clearly highlights the value of our
approach: slow and steady wins the race. We are focused on growth, but not at the expense of profitability.
In 2008, direct written and assumed premiums increased 8.1% over the prior year to $170.7 million.
Premium growth was achieved in both of the Canadian divisions in 2008. Despite difficult industry conditions,
direct written premiums from Personal Lines increased 10.4% to $107.5 million, with non-standard auto growing
6.3% and the motorcycle line increasing by 20.1%. The Niche Products division generated written premiums of
$49.3 million in 2008, compared to $48.1 million in 2007. These results were achieved despite a $7.6 million
decrease in travel health premiums written as we focused on re-engineering this program during the year. These
changes led to substantial year-over-year improvements in the latest travel season, and we continue to believe this
program offers significant growth potential. The other Niche lines of business recorded significant growth in
2008 compared to 2007 and we continue to view this division as a primary source of growth for EGI.
The combined ratio for the year ended December 31, 2008, was 99.9% compared with 91.4% for the
previous year. The loss ratio in 2008 was 67.3% and the expense ratio was 32.6%, compared with 59.5% and
31.9%, respectively, in the same period last year.
Underwriting income for 2008 decreased to $0.2 million, compared to $10.2 million for the previous year.
Underwriting income from the Personal Lines division was $7.1 million, down from $10.6 million in 2007. The
underwriting loss from the Niche Products division was $3.2 million, compared with a gain of $0.3 million in
2007, mainly reflecting the higher loss ratio caused by adverse claims experience in the travel health line of
business from the 2007/2008 travel season. This resulted in an increase in the combined ratio to 106.9% in 2008,
compared to 98.8% in 2007. Underwriting income for 2008 also includes an underwriting loss of $2.4 million
from the International division.
With our conservative investment strategy, EGI minimized the potential negative effect of the steep
downturn in the financial markets that is hampering many North American P&C companies. Investment income
from our portfolio was $10.0 million in 2008, compared with $12.9 million in 2007. The decline reflects $4.7
million of investment impairments recorded at year end, as a result of the significant decline in Canadian equity
markets and evidence of other-than-temporary fair value deficiencies in certain investments.
While profitability was affected by the increased loss ratio and investment losses in 2008, the Company
generated net income of $6.0 million, compared to $15.1 million in 2007. Fully diluted net income per share was
$0.53 in 2008, compared to $1.45 last year.
As we look ahead, we anticipate the Company will produce improving financial results in 2009 while
focusing on profitable diversification and expansion initiatives.
We remain intensely focused on diversifying our business beyond the Ontario non-standard automobile
market through three main strategies: profitably growing our Niche Products division; pursuing opportunities in
new geographic markets and new vehicle types such as motorcycles, antique autos, other recreational vehicles;
and expanding our underwriting business in the United States.
5
Letter to Shareholders 2008
EGI Financial Holdings Annual Report 2008
While underwriting results in the Canadian P&C industry trend downward toward historic norms, EGI’s new
business initiatives continue to provide shareholders with significant growth opportunities. We strongly believe
large insurers will further retrench back into their core, standard risk markets as we move deeper into 2009, as
evidenced by an overall tightening bias in underwriting rules among the standard line insurers. With Echelon now
very clearly seen by brokers as the gold standard within the Canadian non-standard auto marketplace, we are
favourably positioned to increase our market share without sacrificing our strict underwriting or pricing discipline.
Our Niche Products division continues to demonstrate its outstanding growth potential and we continue to
build on it with a number of strategies, including ongoing development of new programs, diversification by line
and continued expansion of our distribution base.
Our International division has stepped up efforts in reviewing and assessing opportunities in the United
States aimed at establishing a more meaningful platform for future growth. With an experienced senior
management team already in place, we have reduced the risk associated with acquiring and effectively integrating
future acquisition targets.
As the cornerstone of our U.S. strategy to transition to an insurer, we are establishing Echelon Insurance
Company of America. Upon receiving regulatory approval, this new insurance company will ultimately service
selected states in the large southeast non-standard auto market. This platform will enable EGI Financial to enter
the market in a highly controlled way, with approval and start-up expected by the second quarter of 2009. In
conjunction with planned organic growth from this platform, we are actively reviewing potential acquisitions to
accelerate our entry into this market.
With a strong balance sheet, EGI remains favourably positioned relative to its competitors, which provides us
with the ability to exploit growth opportunities as they arise. Our experienced senior management team has
proven ability to surface value in challenging markets, and I am more confident than ever that the elements are in
place to enable EGI to profitably evolve into a much larger organization.
I would like to thank both our Board of Directors for their continued counsel and oversight and our dedicated
employees for their hard work in a challenging year. Their continued commitment and dedication will contribute
to our growth and success in 2009 and beyond. In closing, I would also like to thank you, our shareholders, for
your continued support.
Sincerely,
Douglas E. McIntyre,
Chief Executive Officer
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For the period ending December 31, 2008
References to “EGI” in this Management’s Discussion and Analysis of Financial Condition and Results of
Operations refer to EGI Financial Holdings Inc. on a consolidated basis, both now and in its predecessor forms.
The following discussion should be read in conjunction with EGI’s audited consolidated financial statements
and the related notes. The following commentary is current as of March 13, 2009. Additional information
relating to EGI is available on SEDAR at www.sedar.com. Certain totals, subtotals and percentages may not
reconcile due to rounding.
EGI uses both Canadian generally accepted accounting principles (GAAP) and certain non-GAAP measures
to assess performance. Securities regulators require that companies caution readers about non-GAAP measures
that do not have a standardized meaning under GAAP and are unlikely to be comparable to similar measures used
by other companies. EGI analyzes performance based on operating income and underwriting ratios such as
combined, expense and loss ratios.
The following discussion contains forward-looking information that involves risk and uncertainties based on
current expectations. This information includes, but is not limited to, statements about the operations, business,
financial condition, priorities, targets, ongoing objectives, strategies and outlook for EGI in 2009 and subsequent
periods.
This information is based upon certain material factors or assumptions that were applied in drawing a
conclusion or making a projection as reflected in the forward-looking information. By its nature, this information
is subject to inherent risks and uncertainties that may be general or specific. A variety of material factors, many
of which are beyond EGI’s control, affect the operations, performance and results of EGI and its business and
could cause actual results to differ materially from the expectations expressed in any of this forward-looking
information (see “Risk Factors”).
EGI’s actual results could differ materially from those anticipated in this forward-looking information as a
result of various factors, including those discussed in this Management’s Discussion and Analysis. Forward-
looking information is provided for the purpose of providing information about management’s current
expectations and plans relating to the future. Readers are cautioned that such information may not be appropriate
for other purposes. Additional information about the risks and uncertainties about EGI’s business is provided in
its disclosure materials, including its annual information form, filed with the securities regulatory authorities in
Canada, available at www.sedar.com. EGI does not undertake to update any forward-looking information.
Underwriting income and interest expense for 2007 in the following table has been restated to reflect the re-
allocation of interest expense, related to corporate indebtedness, as a separate line item after investment income in
2008. The restatement was made for comparative purposes only and does not affect net income after taxes.
7
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Financial Highlights
Year ended December 31
($ THOUSANDS EXCEPT PER SHARE AMOUNTS) 2008 2007 2006 2005
Pro
Forma
2004 2004
Revenue
Direct written and assumed premiums
Personal Lines/Auto $121,410 $109,870 $ 97,932 $105,567 $109,251 $54,626
Niche Products 49,320 48,065 19,902 11,439 3,765 2,614
Total direct written premiums 170,730 157,935 117,834 117,006 113,016 57,240
Net written premiums 158,107 146,511 106,047 91,783 69,230 35,217
Net earned premiums 157,255 119,606 103,942 76,344 65,890 33,615
Other revenue – – 1 227 298 298
Total underwriting revenue 157,255 119,606 103,943 76,571 66,188 33,913
Underwriting expenses
Incurred claims 105,837 71,179 59,503 45,997 44,075 22,400
Acquisition costs 37,026 26,143 19,499 12,073 10,832 5,638
Operating expenses 14,229 12,043 10,431 9,083 7,762 4,506
Total underwriting expense 157,092 109, 365 89,433 67,153 62,669 32,544
Underwriting income (loss) 163 10,241 14,510 9,418 3,519 1,369
Investment income 10,009 12,954 11,033 7,527 6,591 3,419
Interest expense 1,216 259 – – – –
Income before income taxes 8,956 22,936 25,543 16,945 10,110 4,788
Income tax expense (recovery)
Current 3,453 7,839 9,832 7,505 2,310 1,155
Future (476) 32 (1,270) (1,768) (1,143) (1,085)
2,977 7,871 8,562 5,737 1,167 70
Income from continuing operations 5,979 15,065 16,981 11,208 8,943 4,718
Income from discontinued operations, net of income taxes – – – – 1,308 1,308
Extraordinary gain – – – 5,669 – –
Net income $ 5,979 $ 15,065 $16,981 $ 16,877 $ 10,251 $ 6,026
Net income per share basic $ 0.57 $ 1.56 $ 1.76 $ 2.09 $ 1.29 $ 1.31
diluted $ 0.53 $ 1.45 $ 1.67 $ 1.96 $ 1.28 $ 1.30 Net operating income (1) $ 9,083 $ 12,957 $15,302 $ 10,440 $ 7,767 $ 4,130
Net operating income per share - diluted $ 0.80 $ 1.24 $ 1.50 $ 1.23 $ 0.97 $ 0.52
(1) Net operating income is defined as net income plus or minus after-tax realized losses or gains on sale of investments as shown below:
Net income from continuing operations $5,979 $15,065 $16,981 $11,208 $8,943 $4,718 Add losses (deduct gains) from sales of investments 4,833 (3,350) (2,623) (1,221) (1,837) (919) Tax impact (1,729) 1,242 944 453 661 331
Net operating income $9,083 $12,957 $15,302 $10,440 $7,767 $4,130
Management’s Discussion and Analysis 2008
As at December 31
($ THOUSANDS) 2008 2007 2006 2005 2004
Balance Sheet Data Cash and short-term deposits $ 29,111 $ 22,785 $ 17,153 $ 15,899 $ 7,327 Investments 259,774 238,310 179,383 152,736 57,098 Total assets 402,780 370,084 288,439 260,731 110,737 Provision for unpaid claims 185,255 169,091 146,101 129,173 54,149 Unearned premiums 71,154 69,190 43,154 39,973 17,933 Bank indebtedness 19,550 19,550 – – 1,590 Total shareholders’ equity 118,604 101,671 86,041 72,585 25,309
The following table shows the Company’s selected financial ratios and return on equity (ROE) data. These
ratios are defined in the “Glossary of Selected Insurance Terms”.
Selected Financial Ratios
(1)and ROE Data (%) 2008 2007 2006 2005 2004
Loss ratio 67.3 59.5 57.2 60.3 66.6 Expense ratio 32.6 31.9 28.8 27.7 30.2
Combined ratio 99.9 91.4 86.0 88.0 96.8
ROE 5.4 16.1 21.4 30.1 27.0 Adjusted ROE (2) 5.4 16.1 21.4 25.9 23.0
(1) The underwriting ratios (the loss and expense ratios and the combined ratio) are all non-GAAP measures which are common insurance industry measures of performance.
(2) Excludes the after-tax effects resulting from acquisitions and divestitures including the corresponding adjustments to shareholders’ equity (see “Significant Transactions”).
2008 Financial Overview
Net income after taxes for 2008 was $6.0 million, a decrease of $9.1 million, or 60%, compared to net income
of $15.1 million in 2007. Underwriting income declined to $0.2 million in 2008 compared to $10.2 million for
the full year 2007 and investment income (including realized gains (losses)) declined to $10.0 million from $12.9
million in 2007.
The significant decline in underwriting income was primarily attributable to adverse loss experience related to
the Emergency Travel Health (ETH) business for the 2007–2008 travel season.
Investment income in 2008 included investment impairments of $4.7 million recorded as at December 31,
2008, primarily related to EGI’s common equity portfolio. Management has recorded these impairments as a
result of the significant decline in Canadian equity markets and evidence of other-than-temporary fair value
deficiencies in certain investments.
Net operating income, defined as net income excluding after-tax realized losses/gains, including impairments
on the sale of investments, was $9.1 million for the year ended December 31, 2008 compared to $13.0 million in
2007. The decrease of $3.9 million, or 29%, is much lower than the decline in net income primarily due to the
investment impairments of $4.7 million recorded at year-end 2008.
9
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Overview of EGI
EGI operates in the property and casualty (P&C) insurance industry in Canada and, commencing in 2007, in
the United States, primarily focusing on non-standard automobile insurance and other niche and specialty general
insurance products. Founded in 1997 as an insurance and reinsurance broker and marketer, EGI has since
developed its business to focus on underwriting opportunities not served by many of the larger, standard insurers.
EGI operates through two Strategic Business Units (SBUs) in Canada, the Personal Lines division and the
Niche Products division. The Personal Lines division was created in 2006 to transition the Automobile division
into a multi-product, multi-line SBU. Currently, the Personal Lines division continues to focus on the
underwriting of non-standard automobile insurance and motorcycle business but has expanded into other non-
standard products and specialty lines of business. Through its Niche Products division, EGI designs and
underwrites specialized non-auto insurance programs, such as higher premium property, primary and excess
liability, legal expense and accident and health insurance for a variety of businesses and consumers and extended
warranty coverage for homes and consumer products.
In addition to the two SBUs in Canada, EGI also formed the International division in 2008 to leverage its
strategy to expand into the United States. Currently, this division is focused on personal lines business,
predominantly non-standard automobile insurance. As an interim step to execute this strategy, EGI entered the U.S.
non-standard auto insurance market under reinsurance agreements with three arms-length insurance companies.
These companies provide property and casualty insurance to the non-standard private passenger automobile segment
of the industry and operate in several states in the southeastern U.S. Being dissatisfied with the results of these
arrangements, EGI terminated the reinsurance agreements. EGI now intends to pursue its U.S. expansion
exclusively as an insurer in its own right, where the Company can exercise greater underwriting control.
By pursuing its focused niche strategy, EGI’s objective is to produce an ROE superior to the Canadian P&C
insurance industry average. A key factor for EGI’s ROE to outperform the industry is for its loss ratio to be
below the industry average.
Management’s Discussion and Analysis 2008
The charts below illustrate EGI’s and the P&C insurance industry’s automobile loss ratios and return on equity.
Loss Ratio (%) ROE (%) (2)
76.0%
67.4%
61.6%57.9%
59.1%
65.6%
82.7%
70.5%68.9%
71.3% 71.8%
77.3%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
2003 2004 2005 2006 2007 2008
EGI (Auto) P & C Industry
(1)
(1) Source for P&C industry data: MSA Research Inc. (data represents over 92% of Canadian primary writers when measured on a premium volume basis).
(2) EGI results for 2003 and 2004 include net income from discontinued operations. 2005 results include extraordinary gain.
Approximately 71% of EGI’s written premium revenue in 2008 was from its Personal Lines business in
Canada with approximately 62% of total premiums underwritten in Ontario. A further 8% of premiums were
written in the U.S. pursuant to assumed reinsurance arrangements. The breakdown of direct written premiums by
category of business and by region during 2008 is illustrated below.
2008 Gross Written Premiums by Category 2008 Gross Written Premiums by Region
Net earned premiums from the sale of Personal Lines policies (Canada and United States combined) account
for 71% of net earned premiums. One of EGI’s diversification strategies is the growth of the non-auto business in
the Niche Products division, currently accounting for approximately 29% of net earned premiums, and the growth
of the newly created International division.
Ontario
61.5%
USA
8.2%
Quebec
15.1%
Alberta
5.6%
BC
5.2%
Other
4.5%
Auto
71.1%
Niche28.9%
19.1%
27.0%30.1%
21.4%
16.1%
5.4%
11.2%
19.1% 18.9%17.5%
14.9%
5.3%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
2003 2004 2005 2006 2007 2008
EGI
P & C Industry
11
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
The financial performance of EGI is determined by two main factors: (i) the level of premiums earned in
relation to claims and operating costs incurred; and (ii) the returns generated from the investment portfolio.
Premiums collected are ultimately used to pay claims and operating expenses. There is, however, a time lapse
between the collection of premiums and the payment of claims and certain operating expenses. This allows EGI
to invest premiums collected and earn an investment return until claims and operating expenses are paid. EGI
also earns an investment return on invested capital.
EGI’s results also include fees for consulting, and income from one-time gains from acquisitions and
divestitures and from corporate and other activities. The income from the non-operating transactions is discussed
in the “Significant Transactions” section.
Outlook
In 2008, the impact of past actions taken by the standard insurers began to surface in the form of escalating
industry auto loss ratios, partly because of inadequate pricing that the standard writers were offering for the non-
standard auto business. The erosion of underwriting margins in the P&C industry in 2008 and potentially in 2009
will likely cause the standard insurers to reverse their actions taken earlier to gain market share. Many of the auto
insurers have filed for rate increases in 2008 to improve their margin and this trend is expected to continue in
2009. Additionally, the current economic and financial crisis will negatively impact the investment income of
most insurance companies, if not all, and therefore the industry as a whole will be focusing to a greater degree on
the underwriting income element of their earnings. EGI’s management feels that these changes will create
opportunities for non-standard insurers as standard insurers’ margins erode on this higher risk business, leading
them to return to their traditional standard risk markets. Through the contracting market phase, EGI has
preserved its capital and focused on profitable lines of business and thus is well positioned to take advantage of
the opportunities that the changing market cycle may offer.
In addition to the attractive opportunities that EGI management expects for the non-standard auto business, it
also sees similar opportunities to grow the Niche Products business and to continue to pursue its diversification
strategy. EGI has laid the groundwork in the past few years to aggressively expand the Niche line of business.
As part of that expansion process the Company started to underwrite ETH insurance in 2007. ETH is a multi-
billion dollar segment of the Accident and Sickness insurance industry that is growing due to the aging of the
Canadian population.
The Company will continue to pursue opportunities to grow its U.S. business, in a tax effective manner, by
creating and/or acquiring its own U.S.-domiciled insurer and by continuing to utilize its wholly owned
subsidiaries, CIM Reinsurance Company Ltd. (CIM Re), which is domiciled in Barbados and EGI Insurance
Services, Inc. (EGIS), based in Atlanta, Georgia. EGIS is staffed with a small team of experts in U.S. niche and
specialty lines of business that has performed the initial due diligence and ongoing monitoring of CIM Re’s
existing and potential reinsurance clients. Our U.S. staff has now turned its attention to establishing EGI’s
presence as an insurer in the U.S. market.
EGI will also continue to seek out opportunities for profitable growth either through expansion of its existing
business or by select acquisitions in Canada and the United States.
Management’s Discussion and Analysis 2008
Strategy
EGI’s business strategies and actions are guided by its vision: “Strives to be the pre-eminent writer of
specialized, niche insurance products”. EGI’s objective is to deliver an ROE superior to the average of the
Canadian P&C insurance industry through a comprehensive specialized insurance offering. EGI’s focus is on
non-standard auto and targeted niches that are currently underserved by the market and which require the high
level of underwriting and claims expertise of EGI’s management team and staff.
For 2009, EGI’s strategic goals remain focused on driving profitable business growth by leveraging and
building on its strengths.
In order to achieve this objective, EGI intends to:
Maintain and grow its core non-standard auto insurance offering. EGI concentrates on what it considers to
be the best accounts from the non-standard segment, which has resulted in above-average underwriting margins.
The Company will continue to provide superior policy issuance and underwriting capabilities to its brokers and
agents to support and expand its offering in this market segment. In addition, focusing primarily on return on
equity, EGI will consider returning to markets from which the Company previously exited if long-term profitable
opportunities arise.
Introduce new and innovative niche insurance products and programs. Working closely with Managing
General Agents (MGAs) and other producers, EGI will continue to design niche and specialty programs that are
not offered by traditional insurers. As many brokers need specialty insurers to cover all of their customers’
insurance requirements, EGI’s Niche Products division continues to respond to this market opportunity.
Provide industry-leading service. EGI strives to provide optimum service to its policyholders and producers.
EGI has created and implemented written service standards in all departments interfacing with policyholders or
producers. Staff members in these departments are thoroughly trained in the delivery of quality service to achieve
these standards at a minimum. This service commitment ensures its policyholders and producers continue to be
served by knowledgeable employees in a responsive manner.
Continue to invest in technology. EGI invests in technology where opportunities exist to enhance the
producers’ ease of doing business, create operating efficiencies and improve EGI’s data analysis capabilities.
EGI developed and introduced its proprietary ADAPT® policy and claims management data processing system to
streamline the management of its niche programs and will continue to employ leading technology solutions to
serve its customers. With recent technological advancements, EGI has implemented a program to internalize its
claims administration processes to enhance customer service and decrease administration costs. Claim forms are
available to claimants immediately over the Internet from a computerized forms library that allows greater
efficiencies in dealing with claimants directly. Much of the historical duplication of process and expense has
been eliminated.
Pursue acquisitions. EGI intends to continue to grow its business by seeking attractively priced acquisitions
of insurers or books of business in markets and business lines that are compatible with EGI’s strategic objectives.
With the current financial crisis, EGI anticipates that there will be further consolidation of insurance companies
on both sides of the border and there will be continued downward pressure on the asking price of companies that
become available for sale. As a result, EGI sees a tremendous opportunity to execute its growth strategy by
seeking out attractively priced acquisitions.
13
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Competitive Strengths
EGI believes that it is uniquely positioned to compete in the P&C insurance industry for the following reasons:
Comprehensive specialized insurance offering. EGI offers its producers, both agents and brokers and through
MGAs, a comprehensive line of insurance products comprised of non-standard automobile insurance and
specialized non-auto insurance products and programs. Responding to a market need, EGI thoroughly researches
a product opportunity and develops underwriting procedures and ratings that will both meet the customers’
requirements and earn an attractive ROE for EGI. The Company then arranges for distribution through its
selected distribution channels.
Entrepreneurial culture. EGI fosters an entrepreneurial environment which encourages innovation in
the development of new niche programs and the flexibility to allow for unique, tailor-made solutions to meet
market demand.
Strong customer service focus. EGI believes that it has a strong reputation for customer service with its
producers and policyholders from both an underwriting and a claims standpoint. Automobile policies are
typically issued in five business days or less from receipt of the completed application. In the last published
Automobile Claims Satisfaction Survey (2005) of insurers, EGI ranked highest among its non-standard auto
competitors. Also in a recent survey of brokers by the Insurance Brokers Association of Ontario, EGI ranked the
highest among non-standard auto writers. Because of limited competition in niche markets, EGI believes that its
strong customer service focus provides stability to the existing business and future growth opportunities with
existing and new producers.
Financial strength. EGI has a strong capital base relative to its current underwriting commitments, as evidenced
by the strong Minimum Capital Test ratio of its main insurance subsidiary. Echelon’s Minimum Capital Test ratio
as at December 31, 2008 was 268% compared to the P&C insurance industry average Minimum Capital Test ratio of
224% (as per OSFI’s third-quarter 2008 information). EGI intends to preserve and grow its underwriting capital
through appropriate pricing, underwriting discipline and conservative loss reserving practices.
Experienced management team. EGI has a seasoned group of owner-managers who have worked together
successfully for years. With an average of over 20 years of experience in senior positions within the insurance
industry, the executive management team has extensive knowledge in non-standard and niche insurance products
together with an entrepreneurial thrust and a decisive, collegial management style.
Personal Lines Division
As part of its strategic planning and analysis process, EGI has moved to diversify its writings, both
geographically and by product line, including the creation, development, marketing and processing of new
personal lines product offerings.
These new offerings, in conjunction with the Company’s core, non-standard automobile product, will provide
distributors with a wider array of personal lines products (which have historically been underserved by the
standard market). This will be accomplished by utilizing the same “niche underwriting philosophy and
discipline” that has been the hallmark of EGI’s activities.
Although the non-standard automobile segment remains as the largest, single component of EGI’s activities,
the additional personal lines products will facilitate additional production and diversification, making the
Company an even more important partner for its distributors. In this manner, the non-standard automobile
segment will continue to form the critical, though not sole, component of the Personal Lines division.
Management’s Discussion and Analysis 2008
The non-standard automobile segment currently targeted by EGI’s Personal Lines division is high premium
insurance for drivers who, because of inexperience or a poor driving record, are not able to obtain insurance from
standard insurers. EGI provides coverage for private passenger vehicles as well as single commercial vehicles
and small commercial and farm fleets. Management believes that EGI’s underwriting discipline and claims
expertise, strict controls and an experienced management team (who are well versed in the nuances of non-
standard auto) enable the Company to select those drivers in the higher premium categories who have a
proportionally lower potential claims risk.
For applicants paying the higher premiums for non-standard automobile insurance, price is the single most
important consideration. EGI provides selected drivers with a lower premium option than the higher premium
coverage offered by the Facility Association (or the Groupement in Quebec), the industry-operated pools that
serve as the “market of last resort.” EGI targets drivers most likely to be “reformers” not “repeaters”. These non-
standard auto risks fall between Facility and the applicants normally targeted by standard market insurers. The
likely reformer expresses concern with respect to his or her poor driving record and exhibits a sincere desire to
improve (so as to re-enter the standard market at standard rates). EGI trains its brokers and agents to select
qualifying risks. EGI then employs the experience of its underwriting personnel to ensure that complete and
accurate underwriting and rating information has been developed.
In recent years, EGI focused on appointing brokers and agents in “rural” and “smaller urban” centres in its
markets due to concerns regarding growth in the number of fraudulent claims in the largest urban centres. This
strategy has resulted in enhanced underwriting margins that, on average, exceed the industry average.
In July 2005, EGI withdrew from the Alberta personal lines automobile insurance market. The Alberta
government’s auto insurance reform package (introduced in October 2004) imposed a capping of insurance
premiums, particularly for inexperienced and other higher risk drivers, through the implementation of a mandated
rating grid and clearly defined risk selection rules. The grid subsidizes the premiums of higher-risk drivers which
resulted in the overcharging of lower-risk drivers in Alberta. The size of this subsidy remains large. Recently,
approved grid rate changes have made re-entry into the Alberta private passenger market a viable option, one that
EGI is currently evaluating. EGI presently underwrites motorcycle, commercial, small fleet and farm vehicle
insurance in Alberta.
In September 2005, EGI also withdrew from the Newfoundland and Labrador private passenger automobile
insurance market. This decision was made as a result of the introduction of Bill 26, which eliminated an insurer’s
ability to use statistically valid rating factors (such as number of years licensed) which are essential to the proper
underwriting of non-standard risks. The regulatory changes made it, in the opinion of management,
uneconomical for a non-standard automobile insurer to underwrite the higher risk, private-passenger business for
its own account in Newfoundland and Labrador.
As part of the strategy to develop business in other vehicle types, in the first quarter of 2006 EGI entered into
an exclusive arrangement with a specialist broker to write motorcycle business in Ontario. Direct written
premiums from this arrangement, along with producers of motorcycle business in other jurisdictions, totaled $16.7
million in 2008 and $13.9 million in 2007.
EGI will maintain and grow its personal lines business by employing the following strategies:
• Expand non-standard auto writings in jurisdictions where EGI earlier withdrew or restricted its premium
writing – such as Prince Edward Island, Nova Scotia and New Brunswick – via new rates filed in 2007.
15
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
• Continue to monitor and participate in the review of Alberta’s grid rating system by the Alberta Automobile
Insurance Rate Board, with a view to reactivating distribution of EGI’s private passenger automobile
insurance coverages in that province (should a viable opportunity be proven).
• Monitor the impact of recent government reforms in Ontario aimed at further reducing fraudulent claims,
which may allow EGI to increase its business activities in additional urban markets.
• Continue to build the Company’s profitable personal and commercial auto lines of business in the province of
Quebec. Personal lines production in Quebec (in 2008) totaled $10.6 million (a 16.5% increase compared to
2007). Quebec remains a critical territory in EGI’s efforts to diversify geographically.
• Use EGI’s non-standard underwriting expertise to add other lines of specialty personal lines insurance
products such as coverage for motorcycles (Alberta), snowmobiles, all terrain vehicles, antique autos and
recreational vehicles.
Niche Products Division
EGI’s Niche Products division, established in 2003, provides specialized commercial and personal insurance
products and programs covering areas of the market that are considered underserved. This division works with
property and casualty insurance brokers, MGAs, benefit consultants, warranty-product distributors and third party
administrators (TPAs) to design insurance and warranty product solutions that respond to gaps in the insurance
market created by traditional insurers’ focus on standardized coverage. The division is focused on satisfying its
distributors’ need for customized consumer-oriented solutions that differentiate them from the product offerings
provided by standard market insurers. Staffed with highly knowledgeable and experienced insurance
professionals, the division researches and designs specialty insurance programs in response to market demand.
These programs are then distributed and administered by the initiating broker, MGA, TPA or other intermediary
who has worked closely with the division to design the insurance solution. EGI believes that the direct written
premiums for its target specialized niche product insurance segment are approximately 8% to 10% of the non-auto
P&C insurance market and 5% of the accident and health insurance market.
EGI has identified niche market segments within five product areas that offer opportunities for profitable
growth: property insurance; commercial general liability and professional liability insurance; casualty insurance;
accident and health insurance; and warranty products. Within each of these areas, EGI concentrates its
underwriting within the sub-segments where the risk characteristics of the business offer an opportunity to obtain
a higher rate relative to the specific exposure than would be available within the broader segment of that niche
market. This focus allows EGI to seek a per-risk margin that exceeds what is available in the standard market.
An important component of the niche products market is the degree to which significant expertise often
resides at the broker and distributor level. The distribution partners we select have highly specialized knowledge
of the product and the market as well as administration systems to service the customer before and after the sale.
They provide highly effective distribution capability for EGI’s programs. Their market knowledge and technical
design capability are used in product design and, combined with EGI’s expertise in pricing, underwriting
structures and financial management, create a sustainable product offering. Many of our distribution partners are
interested in sharing in future underwriting profits through retention of risk. Accordingly, in certain
circumstances, EGI will enter into a risk-sharing agreement with a distribution partner.
In response to the growth experienced in the Niche Products division, the ADAPT® system was developed to
enable the administrator of each program to provide customer information to EGI in an electronic format on
contracts and policies sold by the distributor. The ADAPT® system software uploads customer data provided by
Management’s Discussion and Analysis 2008
the administrator of the program in preset formats supplied by EGI. The ability to export data avoids costly
duplication and allows the distributors to use their own internal systems to supply the required information to EGI
rather than being forced to re-enter data on EGI’s systems. Once the data transfer is received, EGI is able to
immediately create customer policy records on the ADAPT® system and can use the claims portion of the
ADAPT® system to manage claims and provide customer service.
EGI intends to maintain and grow the niche programs business by employing the following strategies:
• Continue to broaden market awareness of the existence and capabilities of EGI’s Niche Products division
(including EGI’s risk retention structuring capabilities) by directly contacting and making presentations to
qualified brokers and other insurance product distributors.
• Ensure that the Niche Products division grows organically by continuing to provide unique expertise and
superior service in response to all business inquiries.
• Seek opportunities for the Niche Products division to grow through select acquisitions of books of business,
distributors, administrators or an insurance company.
• Attract high quality profitable program business by offering a unique opportunity for distribution partners to
enter into risk-sharing arrangements with EGI.
International Division
In January 2008, EGI formed the International division to focus on its strategy to expand into the US. As an
interim step to execute this strategy, EGI entered the U.S. non-standard auto market under reinsurance agreements
with three arms’-length insurance companies. EGI has terminated the reinsurance agreements, being dissatisfied
with the results.
With the termination of the assumption of business from selected U.S. insurers, the Company is now undertaking
to launch a new and/or acquire a suitable existing non-standard automobile insurance company. The new, or acquired
company, will be domiciled in the United States and licensed in one or more states which EGI believes constitute
attractive markets, to contribute to EGI’s goal of earning superior returns. EGI’s management team has past
experience with the acquisition and operation of U.S., non-standard auto carriers. Any such acquisitions could also
serve as an entry point, for the personal lines product offerings (noted above) into the U.S. market.
Segmented Financial Information
The International division’s 2008 results include all premiums assumed pursuant to reinsurance arrangements
with U.S.-based, non-standard automobile insurers. This business was previously included in the Personal Lines
division (U.S.) in 2007, and these figures have been re-stated for comparative purposes in the table below.
The segmented information for the final quarter of 2008 and full year show significant growth in underwriting
revenue for each of the business segments of EGI. The growth in Personal Lines premiums resulted from
increases in both the non-standard automobile and motorcycle lines of business. The growth in Niche Products
premiums resulted from continued growth in this part of our business, which is maturing into a significant portion
of EGI’s book of business. Premium growth in the International division is related to assumed reinsurance
premiums from quota share arrangements with three non-standard automobile reinsurers based in south-eastern
United States.
17
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
For the three months ended
December 31, 2008
For the three months ended
December 31, 2007
Canada International Canada International
($THOUSANDS)
Personal Lines
NicheProducts Total
Personal Lines
NicheProducts Total
Underwriting
revenue 25,500 10,235 35,735 3,811 22,536 9,192 31,728 2,432
Underwriting
income (loss) 466 186 652 (999) 2,054 (966) 1,088 (73)
Loss ratio 70.4% 56.5% 66.4% 90.3% 61.0% 73.4% 64.6% 72.0%
Expense ratio 27.8% 41.7% 31.8% 35.9% 29.9% 37.1% 32.0% 31.0%
Combined ratio 98.2% 98.2% 98.2% 126.2% 90.9% 110.5% 96.6% 103.0%
The segmented information for the fourth quarter of 2008 shows that both the Personal Lines and Niche
Products divisions contributed underwriting income of $0.5 million and $0.2 million, respectively. The
International division recorded an underwriting loss of $1.0 million in the period.
The fourth quarter 2008 Personal Lines results represent a decrease in underwriting income of $1.5 million
compared to the underwriting income of $2.0 million in the fourth quarter of 2007. This was primarily due to an
increase in the loss ratio to 70.4% in the 2008 period compared to 61.0% for the final quarter of 2007. The fourth
quarter 2008 loss ratio was negatively impacted by a market yield adjustment due to the decline in the actuarial
discount rate used in 2007 of 2.8%, to 2.5% in 2008.
Underwriting income in the quarter of $0.2 million for the Niche Products division represents a significant
improvement compared to the underwriting loss of $1.0 million recorded in the final quarter of 2007. A decline
in the loss ratio to 56.5% in 2008, compared to 73.4% for the same period in 2007, was the primary factor in this
improved result. As also noted in the segmented information year-over-year comparison, the improvement in the
ETH line of business loss ratio contributed to this positive result.
The underwriting loss of $1.0 million recorded in the International division was the result of adverse claims
experience during the quarter, resulting in a loss ratio of 90.3% for the period compared to 72.0% in the final
quarter of 2007.
2008 2007
Canada International Canada International
($THOUSANDS)
Personal Lines
NicheProducts Total
Personal Lines
NicheProducts Total
Underwriting
revenue 98,665 46,009 144,674 12,581 87,700 23,900 111,600 8,006
Underwriting
income (loss) 7,058 (3,183) 3,875 (2,404) 10,664 297 10,962 (17)
Loss ratio 65.6% 66.0% 65.7% 85.7% 59.1% 56.1% 58.5% 73.9%
Expense ratio 27.3% 40.9% 31.6% 33.4% 28.7% 42.7% 31.7% 26.3%
Combined ratio 92.9% 106.9% 97.3% 119.1% 87.8% 98.8% 90.2% 100.2%
The segmented information on a year-to-date basis shows that the Personal Lines division contributed $7.1
million of underwriting income while the Niche Products division recorded an underwriting loss of $3.2 million
and the International division recorded an underwriting loss of $2.4 million.
Management’s Discussion and Analysis 2008
The Personal Lines business segment recorded an increase in its loss ratio partially offset by a decreased
expense ratio in 2008. Although favourable claims development was lower than in 2007, this line continued to
experience favourable loss development of claims related to prior years, with total net positive development of
prior year claims of $5.1 million in 2008 compared to $11.8 million in 2007. The Personal Lines division
expense ratio decreased slightly to 27.3% compared to 28.7% in 2007 as a result of operating expense controls.
The Niche Products loss ratio increased to 66.0% in 2008 primarily due to a higher-than-expected loss ratio
incurred in the Emergency Travel Health (ETH) insurance business. The loss ratio on this line of business was
94.6% while the loss ratio from all other Niche programs was 45.2% in 2008. This reflects an improvement of
48% (excluding the ETH results) from this business segment compared to the 2007 loss ratio. ETH results
primarily reflect performance related to the 2007–2008 travel season, which for the most part ended June 30,
2008. Management has undertaken a number of initiatives, including premium rate increases, implementing caps
on premiums written by distributors, and stricter underwriting criteria intended to significantly improve the
financial results in the 2008–2009 travel season. As a result, the loss ratio for the 2008–2009 travel season as at
December 31, 2008, was 58.8%, representing a significant improvement over the loss ratio for the 2007–2008
travel season of 91.9% as at December 31, 2007. The Niche Products division expense ratio decreased to 40.9%
in 2008, compared to 42.7% in 2007, primarily due to the increase in earned premiums year over year and the
resulting improved economies of scale related to operating expenses.
The International division incurred adverse claims experience in 2008 resulting in an increase in the loss ratio
to 85.7% compared to 73.9% in 2007. In 2007 and 2008, premiums generated from the International division
were derived from assumed reinsurance contracts with U.S.-based non-standard automobile insurers. The largest
of these contracts was cancelled effective December 31, 2008, with the remaining contracts to be cancelled
effective March 31, 2009.
Revenue
Revenue reflected in the consolidated financial statements includes net earned premiums, investment
income, realized gains and losses on the sale of investments, and other revenue.
($ THOUSANDS) 2008 2007
Gross premiums written 170,730 157,935
Net premiums written 158,107 146,511
Net premiums earned 157,255 119,606
Net interest and dividends 12,136 9,759
Net realized gains (losses) on investments (4,833) 3,350
Foreign exchange gains (losses) 2,706 (155)
Total revenue 167,264 132,560
The main source of revenue was earned premiums from the sale of insurance policies. Gross written
premiums totaled $170.7 million, 8.1% above the $157.9 million level last year. This significant increase was
attributable to premium growth in each of EGI’s business segments. Net earned premiums rose $37.6 million, or
31.4% in 2008, to $157.2 million from $119.6 million last year. This increase was higher than the percentage
increase in written premiums, primarily due to the significant amount of ETH insurance premiums written in the
last quarter of 2007 (compared to the last quarter of 2008) and earned in the first half of 2008.
19
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
The second largest source of revenue was investment income, which constituted approximately 6% of EGI’s
total revenue in 2008. EGI recognizes revenue from interest, dividends, realized capital gains and losses on the
invested assets and foreign exchange gains and losses. Market fluctuations in interest rates affect EGI’s returns
on, and the market value of, fixed income and short-term investments. The fair market value of EGI’s exposure
to preferred and common shares and other equity investments fluctuates as a result of changes in the overall level
of the equity markets. Net losses on invested assets totaled $4.8 million compared to realized gains of $3.4
million last year. The losses in 2008 include an investment impairment of $4.7 million recorded in the last
quarter of the year due to evidence of other-than-temporary fair value deficiencies on specific investments.
Impairment losses recognized in net income do not have an impact on total shareholders’ equity since the fair
values of available-for-sale investments are recorded on the balance sheet. Foreign exchange gains of $2.7
million recorded in 2008, due to the weakened Canadian dollar, arise primarily from cash balances held in U.S.
dollars used to fund claims liabilities, also denominated in U.S. dollars, related to the ETH line of business.
Expenses
EGI’s expenses consist of incurred claims, acquisition costs and operating expenses, including interest on
borrowed funds.
($ THOUSANDS) 2008 2007
Expenses
Incurred claims 105,837 71,179
Acquisition expense 37,026 26,143
Operating expense 14,229 12,043
157,092 109,365
Selected Underwriting Ratios 2008 2007
Incurred claims ratio 67.3% 59.5%
Acquisition expense ratio 23.5% 21.9%
Operating expense ratio 9.1% 10.0%
Combined ratio 99.9% 91.4%
The combined ratio for EGI increased in 2008 to 99.9% from 91.4% in 2007. As noted in the table above, the
primary reason for the increase was the higher loss and acquisition expense ratios in 2008 compared to 2007. The
increased loss ratio was primarily due to adverse experience in ETH claims and assumed reinsurance arrangements
in the International division. The increase in the acquisition expense ratio was primarily due to the change in the
mix of EGI business, with a greater emphasis on Niche Products lines, which attract a larger commission rate
compared to Personal Lines products. The decrease in the operating expense ratio was primarily due to the growth
in earned premiums and the resulting improved economies of scale along with expense controls.
Incurred claims, also referred to as losses, are the amounts payable under insurance policies relating to
insured events. Loss adjustment expenses, also referred to as claim expenses, are the expenses of settling claims,
including allocated (i.e. external) loss adjustment expenses and unallocated (i.e. internal) loss adjustment
expenses (together, LAE). Achieving profitable results depends on EGI’s ability to manage future claims and
other costs through innovative product design, strict underwriting criteria and efficient claims management.
Management’s Discussion and Analysis 2008
Acquisition costs consist mainly of commissions and premium taxes which are directly related to the
acquisition of premiums. Commissions are the amounts paid to producers for selling insurance policies. The
amount of commission is generally a percentage of the premium of the insurance policy sold. Contingent
commissions are paid to brokers and MGAs on an annual basis if they meet certain targets. In general, these
producers have to meet or exceed certain criteria, including written premium targets and profitability, on average
over three years, to qualify for this compensation. Premium taxes are taxes paid by EGI to provincial
governments, calculated as a percentage of direct written premiums.
Operating expenses are the non-commission selling, underwriting, administrative and interest expenses incurred
to support EGI’s business. A significant portion of these expenses is related to employee compensation and benefits.
The effective control and management of these expenses can enhance the underwriting results from the operation.
Significant Transactions
Normal Course Issuer Bid
In December 2008, EGI announced its intention to make a normal course issuer bid. Pursuant to the bid, the
Company proposes to purchase, over the next 12 months, up to an aggregate of 629,030 common shares of EGI,
representing approximately 10% of the public float as of December 31, 2008. As of December 31, 2008, the
Company had not settled the purchase of any shares.
Rights Offering
In July 2008, EGI issued rights to eligible holders of outstanding common shares of record on July 4, 2008, to
subscribe for and purchase an aggregate of 1,943,630 common shares, at a price of $10.75 per share. Completion
of the rights offering on July 31, 2008, resulted in the issuance of 1,943,630 common shares for $20.773 million
in net proceeds to be used for general corporate purposes.
Credit Facility to fund U.S. Expansion
In October 2007, EGI entered into a non-revolving term credit facility with a major Canadian bank in the amount
of US$20 million, converted to CDN$19.55 million, the equivalent Canadian dollar amount as of the closing date.
The facility bears interest of 6.2% which is payable monthly over the three-year term of the agreement. After
three years, EGI is obligated to repay the amounts drawn as at the termination of the agreement. Pursuant to the
credit facility agreement, EGI is required to comply with various financial covenants and financial information
reporting requirements.
The initial drawdown of US$20 million or CDN$19.55 million was used to increase the capital of CIM
Reinsurance Company Ltd., EGI’s Barbados-based subsidiary reinsurance company, which has been used to
reinsure selected niche and specialty line insurers, underwriting business in the United States.
Regulation
The industry in which EGI operates is regulated for the sale of P&C insurance. Changes in these regulations
may significantly affect the operations and financial results of EGI.
21
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Significant Accounting Changes
Capital Disclosures and Financial Instruments – Disclosures and Presentation
On January 1, 2008, the Company adopted three new accounting standards issued by the Canadian Institute of
Charted Accountants (CICA):
Handbook Section 1535 – Capital Disclosures
Handbook Section 3862 – Financial Instruments – Disclosure
Handbook Section 3863 – Financial Instruments – Presentation
Section 1535 specifies the disclosure of (i) an entity’s objectives, policies and processes for managing capital;
(ii) quantitative data about what the entity regards as capital; (iii) whether the entity has complied with any capital
requirements; and (iv) if it has not complied, the consequences of such non-compliance.
Sections 3862 and 3863 replaced Handbook Section 3861, Financial Instruments – Disclosure and
Presentation, revised and enhanced its disclosure requirements, and continued its presentation requirements.
These new standards place increased emphasis on disclosures about the nature and extent of risks arising from
financial instruments and the management of those risks. The new standards did not have an impact on the
financial position or earnings of the Company.
Future Changes in Accounting Policies and Disclosure
Transition to International Financial Reporting Standards (IFRS)
The CICA has announced that Canadian GAAP for publicly accountable enterprise companies will be
replaced with IFRS over a transition period expected to end in 2011. EGI will begin reporting its financial
statements in accordance with IFRS on January 1, 2011. EGI has begun planning its transition to IFRS. The
impact on its consolidated financial position and results of operations has not yet been determined.
Critical Accounting Estimates and Assumptions
EGI’s significant accounting policies are disclosed in note 3 to the consolidated financial statements for the
financial year ended December 31, 2008. The preparation of EGI’s financial statements in accordance with
Canadian GAAP requires EGI to make estimates and assumptions that affect the amounts reported in the financial
statements. These estimates and assumptions principally relate to the establishment of reserves for claims and
expenses, impairments of investment securities, amounts recoverable from reinsurers and certain other assets. As
more information becomes known, these estimates and assumptions could change and impact future results. The
most significant estimates and assumptions made in preparing the financial statements are in respect of policy
liabilities, investments, reinsurance and income taxes.
Policy Liabilities
Policy liabilities consist of provisions for claim liabilities and premium liabilities.
Claim liability reserves are maintained to cover EGI’s estimated ultimate liability for unpaid losses and loss
adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting
period. The provision for unpaid claims and adjustment expenses is first determined on a case-by-case basis as
claims are reported and then reassessed as additional information becomes known. The provision also accounts
for the future development of these claims, including claims incurred but not reported (IBNR). Reserves do not
represent an exact calculation of liability, but instead represent estimates developed using projection techniques in
accordance with Canadian accepted actuarial practice. These reserve estimates are expectations of the ultimate
cost of settlement and administration of claims based on EGI’s assessment of facts and circumstances then
Management’s Discussion and Analysis 2008
known, its review of historical settlement patterns, estimates of trends in claims severity and frequency, legal
theories of liability and other factors.
Variables in the reserve estimation process can be affected by both internal and external events, such as
changes in claims handling procedures, economic inflation, legal trends and legislative changes. Many of these
items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant
reporting lags between the occurrence of the insured event and the time it is actually reported to the insurer.
Reserve estimates are refined in a systematic ongoing process as historical loss experience develops and
additional claims are reported and settled. Because the establishment of reserves is an inherently uncertain
process involving estimates, current reserves may not be sufficient. Adjustments to reserves, both positive and
negative, are reflected in the statement of income for the period in which such estimates are updated.
The provision for unpaid claims and adjustment expenses is discounted to take into account the time value of
money. It also includes a provision for adverse deviation, as required by Canadian accepted actuarial practice.
The appointed actuary of EGI’s subsidiaries, using appropriate actuarial techniques, evaluates the adequacy of the
policy liabilities.
Premium liabilities are considered adequate when the unearned premium reserve (after deducting any deferred
acquisition cost assets) is at least equal to the present value, at the balance sheet date, of the cash flow of claims,
expenses and taxes to be incurred after that date on account of the policies in force at that date or at an earlier date.
Deferred acquisition costs are comprised of commissions, premium taxes and expenses directly related to the
acquisition of premiums. These costs are deferred to the extent that they are recoverable from unearned premiums,
after considering the related anticipated claims, expenses and investment income in respect of these premiums.
Deferred acquisition costs are amortized on the same basis as the premiums are recognized in income.
A premium deficiency would be recognized immediately by a charge to the statement of income as a reduction of
deferred acquisition costs to the extent that the unearned premium reserve, plus anticipated investment income, is not
adequate to recover all deferred acquisition costs and related claims and expenses. If the premium deficiency was
greater than unamortized deferred acquisition costs, a liability would be accrued for the excess deficiency.
Investments
EGI obtains values for all publicly traded securities in its investment portfolio from external pricing services.
Impairment of investment securities results in a charge to earnings when a market decline in the value of an
investment to below cost is considered to be other-than-temporary. EGI’s methodology to identify potential
impairments requires professional judgment and places particular emphasis on those securities with unrealized
losses of 20% or greater of the book value where the unrealized loss has been outstanding for more than six
months. Assessment factors include, but are not limited to, the financial condition and rating of the issuer of the
security, any collateral held and the length of time the market value of the security has been below cost. An
impairment loss is recognized when the assessment concludes that there is objective evidence of impairment and
the decline in fair value is other-than-temporary. Once a security with an unrealized loss is determined to be
other than temporarily impaired, an impairment loss is recorded in the income statement with an offset to
Accumulated Other Comprehensive Income. Previously impaired securities continue to be monitored quarterly.
In 2008, other-than-temporary investment impairments of $4.7 million were recorded in the statement of income.
There are inherent risks and uncertainties involved in making these judgments. Changes in circumstances and
critical assumptions such as a weak economy, a pronounced economic downturn or unforeseen events which
affect one or more companies or industry sectors could result in additional write-downs in future periods for
23
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
impairments that are deemed to be other-than-temporary. See also note 4 to the consolidated annual financial
statements for a description of EGI’s impairment policies.
Reinsurance
Reinsurance recoverables include amounts for expected recoveries related to claims liabilities as well as the
portion of the reinsured premiums which has not yet been earned by the reinsurer. The cost of reinsurance is
accounted for over the terms of the underlying reinsured policies, using assumptions consistent with those used to
account for the policies. Amounts recoverable from reinsurers are estimated in a manner consistent with claim
and claim adjustment expense reserves and are reported in the consolidated balance sheet. The ceding of
insurance liability to a reinsurer does not discharge EGI’s primary liability to the policyholders. The Company’s
policy is to record an estimated allowance for doubtful accounts on the basis of periodic evaluations of balances
due from reinsurers, reinsurer solvency, management’s experience and current economic conditions.
Income Taxes
EGI uses the asset and liability method whereby income taxes reflect the expected future tax consequences of
temporary differences between the carrying amounts of financial statement assets and liabilities compared with
their respective tax bases. Accordingly, a future tax asset or liability is determined for each temporary difference,
based on the income tax rates that are expected to be in effect when the underlying items of revenue and expenses
are expected to be realized.
Future income taxes, accumulated as a result of temporary differences, are included in the consolidated
balance sheet. In addition, the consolidated statement of income contains items that are non-taxable or non-
deductible for income tax purposes, which cause the income tax provision to differ from what it would be if based
on statutory rates.
SUMMARY OF QUARTERLY RESULTS
2008 2007
($ THOUSANDS EXCEPT PER SHARE DATA) Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
Direct written and assumed
premiums 39,948 46,067 49,779 34,936 43,098 42,343 42,299 30,196
Total revenues (excluding
investment income) 39,547 36,150 35,999 45,559 34,161 30,847 29,808 24,790
Underwriting income (489) 1,514 (465) (397) 868 3,536 4,533 1,304
Income (loss) before income
taxes
(3,272) 4,394 3,947 3,888 5,658 6,772 6,601 3,905
Net income (loss) (2,322) 3,026 2,690 2,586 3,727 4,462 4,349 2,527
Earnings per adjusted share
- Basic $(0.20) $0.28 $0.27 $0.27 $0.39 $0.46 $0.45 $0.26
- Diluted $(0.19) $0.26 $0.25 $0.25 $0.35 $0.44 $0.42 $0.24
Selected financial ratios (%)
Loss ratio 68.7 64.0 67.7 68.4 65.1 58.2 53.2 61.0
Expense ratio 32.5 31.7 33.6 32.4 32.3 30.3 31.6 33.7
Combined 101.2 95.7 101.3 100.8 97.4 88.5 84.8 94.7
Management’s Discussion and Analysis 2008
QUARTER ENDED DECEMBER 31, 2008 COMPARED TO QUARTER ENDED DECEMBER 31, 2007
The following financial information compares the results for the fourth quarter 2008 with the fourth quarter
2007.
($ THOUSANDS)Q4
2008
Q4
2007
Variance
$
Variance
%
Direct written premiums 39,948 43,098 (3,150) (7.3) Net written premiums 36,644 39,257 (2,613) (6.7) Net earned premiums 39,547 34,161 5,386 15.8 Claims incurred 27,169 22,253 4,916 22.1 Acquisition costs 8,980 7,483 1,497 20.0 Operating expenses 3,886 3,557 329 9.2 Underwriting income (loss) (489) 868 (1,357) (156.3) Investment income (loss) (2,481) 5,049 (7,530) (149.1) Interest expense 302 259 43 16.6 Net income (loss) before income taxes (3,272) 5,658 (8,930) (157.8) Income taxes (950) 1,931 (2,881) (149.2) Net income (loss) (2,322) 3,727 (6,050) (162.3)
Net operating income 3,037 2,256 781 34.6
Insurance Operation
Written Premiums
In the fourth quarter of 2008, direct written premiums decreased $3.1 million, or 7.3%, to $40 million
compared to $43.1 million in the same period last year. The decrease was the result of a decrease in premiums
generated by the Niche Products division’s ETH line of business. This line of business generated $3.5 million of
premiums, a decrease of $8.0 million, compared to $11.5 million in the final quarter of 2007. The decrease in
premiums in this line of business is due to stricter underwriting restrictions put in place for the 2008–2009 travel
season intended to return this line of business to profitability. Excluding the decline in business in ETH, the
Niche Products division continued to generate premium growth in the last quarter of 2008, with written premiums
of $10.1 million, an increase of $2.4 million, or 31.2% over the same period last year. In our Personal Lines
division, direct written and assumed premiums increased $0.5 million or 2.3% to $22.2 million compared to $21.7
million in the fourth quarter of 2007. Assumed premiums in the International division increased $1.4 million, or
11.2%, to $13.9 million compared to $12.5 million in the last quarter of 2007.
For the three months ended December 31, 2008, net written premiums decreased $2.6 million or 6.6% to
$36.6 million compared to $39.2 million for the last quarter of 2007. This decrease was consistent with the
decrease in direct written and assumed premiums noted above.
Earned Premiums
Net earned premiums for the three months ended December 31, 2008 were $39.5 million, an increase of $5.3
million, or 15.5%, compared to the fourth quarter of 2007. Growth in net earned premiums was achieved despite
the decrease in net premiums written in the final quarter of 2008. This is the result of growth in our other lines of
business (excluding ETH). Since ETH premiums are earned primarily during the winter months (December to
March) the decline in written premiums in this line of business will not fully impact net earned premiums until
25
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
the first quarter of 2009. As noted above, the decline in written premiums in ETH is the result of actions taken by
EGI designed to return this line to profitability for the 2008–2009 travel season.
Incurred Claims Expense
For the quarter ended December 31, 2008, net claims expense increased $4.9 million or 22% to $27.2 million
compared to $22.3 million for the fourth quarter of 2007. This resulted in a loss ratio of 68.7% for the three
months ended December 31, 2008 compared to 65.1% for the same period in 2007. The increase was attributable
to increases in the loss ratios in the quarter for the Personal Lines and International divisions. The loss ratio of
the Personal Lines division was 70.4% in the three month period ended December 31, 2008 compared to 61.0% in
the same period of 2007. The increase in the loss ratio was due to a decline in favourable loss development of
prior-year claims for the Personal Lines business segment compared to the final quarter of 2007. Favourable
development of $0.1 million was recorded in the fourth quarter of 2008, for this business segment, compared to
favourable development of $2.0 million in the same period in 2007. The International division had a loss ratio of
90.3% in the fourth quarter of 2008 compared to 72.0% experienced in the final quarter of 2007. The increase in
2008 was primarily due to adverse claims experience resulting from unfavourable loss development of 2007
accident year claims of $0.2 million from assumed reinsurance business written in this division.
The Niche Products division loss ratio was 56.5% in the last three months of 2008 compared to 73.4% in the
same period last year. This significant improvement is primarily due to the improvement in the ETH loss ratio in
2008. The loss ratio for the ETH line of business was 58.8% in the final quarter of 2008, compared to 91.9% in
the final three months of 2007, reflecting the initiatives taken by management to return this line to profitability for
the 2008–2009 travel season.
On a company-wide consolidated basis, net unfavourable development of prior year claims of $0.2 million
was recorded in the fourth quarter of 2008 compared to favourable development of $2.0 million in the same
period in 2007.
Acquisition Costs
Net acquisition costs, which consist mainly of commissions and premium taxes, increased $1.5 million or
20% to $9.0 million in the quarter ended December 31, 2008, compared to $7.5 million in the same period in
2007. The increase is slightly higher than the increase in net earned premiums of 15.5% due to the higher
proportion of Niche business compared to Personal Lines in 2008, which attracts higher acquisition expenses.
Operating Expenses
For the fourth quarter of 2008, operating expenses were $3.9 million compared to $3.6 million (excluding
interest expense) in the same period in 2007 or an increase of 8.3%. This increase was lower than the 15.5%
increase in net earned premiums in the quarter compared to 2007. As noted above, this is partially the result of an
improvement in economies of scale caused by an increase in ETH net earned premiums relative to written
premiums in 2008.
Underwriting Income
Underwriting results reflect the revenues from net earned premiums less claims, acquisition and operating
expenses. The quarter ended December 31, 2008, had an underwriting loss of $0.5 million, compared to
underwriting income of $0.9 million in the same quarter of 2007. The decline was attributable to the increase in
the loss ratio, primarily from the Personal Lines and International divisions as noted above.
Management’s Discussion and Analysis 2008
Investment Income
In the final quarter of 2008, income from investments decreased significantly to a net loss on investments of
$2.5 million compared to investment income of $5.1 million in the final quarter of 2007. The result was due to
the realization of losses of $3.3 million on the sale of investments during the quarter, and the recording of other-
than-temporary investment impairments of $4.7 million in the period. As noted earlier, as a result of a detailed
assessment of our investment portfolio, EGI has identified specific other-than-temporary investment impairments,
primarily caused by the significant decline in equity markets during the final quarter of 2008 and evidence of
other-than-temporary fair value deficiencies related to specific holdings.
Partially offsetting the realized losses on sale of investments and impairments recorded in the quarter were
foreign exchange gains of $2.3 million. The gain resulted from weakening of the Canadian dollar in the period,
which increased the value of bank balances held in U.S. dollars. As at December 31, 2008, EGI held US$7.7
which was used to fund claims liabilities, also denominated in U.S. dollars, related to the ETH line of business.
Income from interest and dividends totaled $3.2 million in the fourth quarter of 2008 compared to $2.7
million in the same period in 2007, reflecting the increase in the total investment portfolio during the year.
Interest Expense
During the final quarter of 2008, interest expense related to bank indebtedness of $0.3 million was incurred.
In October 2007, EGI entered into a non-revolving term loan facility with a major Canadian bank in the amount
of $19.55 million. During the three-year term of the facility, interest of 6.2% is paid quarterly.
Net Income before Income Taxes
For the quarter ended December 31, 2008, the net loss before income taxes was $3.3 million compared to net
income of $5.7 million for the final quarter of 2007, as the result of a higher 2008 combined ratio of 101.2%,
compared to 97.4% for the same period in 2007, and an aggregate investment loss of $2.5 million incurred in the
period compared to investment income of $5.1 million in the same period of 2007.
Income Taxes
For the quarter ended December 31, 2008, the provision for income taxes reflected a recovery of $0.9 million
compared to an expense of $1.9 million for the same period last year. The 2008 recovery is the result of the net
loss before income taxes incurred in the period. The approximate effective tax rate was 33% for the last quarter
of 2008 and 34% for the same period last year.
Net Operating Income
Net operating income, defined as net income plus or minus after-tax realized losses or gains on the sale of
investments, increased $0.8 million to $3.0 million in the final quarter of 2008 compared to $2.2 million in the
same period in 2007. Net operating income, in the last three months of 2008, consisted of a net loss of $2.3
million plus after-tax realized losses on the sale of investments of $5.3 million, compared to net income of $3.7
million less after-tax gains on the sale of investments of $1.5 million in 2007.
The significant improvement in net operating income in the fourth quarter of 2008, compared to 2007, is
primarily related to the improved results from the ETH line of business as noted above.
27
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
YEAR ENDED DECEMBER 31, 2008 COMPARED TO 2007
The following financial information compares results for the full year 2008 and 2007.
($ THOUSANDS) 2008 2007
Variance
$
Variance
%
Direct written premiums 170,730 157,935 12,795 8.1 Net written premiums 158,107 146,511 11,596 7.9 Net earned premiums 157,255 119,606 37,649 31.5 Claims incurred 105,837 71,179 34,658 48.7 Acquisition costs 37,026 26,143 10,883 41.6 Operating expenses 14,229 12,043 2,186 18.2 Underwriting income (loss) 163 10,241 (10,078) (98.4) Investment income (loss) 10,009 12,954 (2,945) (22.7) Interest expense 1,216 259 957 369.5 Net income (loss) before income taxes 8,956 22,936 (13,980) (60.9) Income taxes 2,977 7,871 (4,894) (62.2) Net income (loss) 5,979 15,065 (9,086) (60.3)
Net operating income 9,083 12,957 (3,874) (29.9)
Insurance Operation
Written Premiums
Direct written and assumed premiums increased $12.8 million or 8.1% to $170.7 million for the year ended
December 31, 2008 compared to $157.9 million for 2007. Premium growth was achieved in both Canadian
business segments. The increase in Personal Lines premiums, despite difficult market conditions in the P&C
industry, was the result of premium growth in non-standard automobile and motorcycle business. Total Personal
Lines division gross written premiums were $107.5 million in 2008 compared to $97.4 million in 2007, reflecting
a growth rate of 10.4%. Non-standard automobile premiums in 2008 totaled $88.4 million compared to $83.2
million in the prior year, with motorcycle premiums of $16.7 million in 2008 compared to $13.9 million in 2007.
The remaining premiums for the Personal Lines division are from other vehicles. Regionally, Quebec automobile
insurance premiums grew 16.5% to $10.6 million for 2008, compared to $9.1 million in 2007.
Direct written premiums for Niche Products increased 2.5% to $49.3 million for 2008, compared to $48.1
million in 2007. This increase was achieved despite a significant decrease of $7.6 million in the ETH written
premiums to $11.5 million from $19.1 million in 2007. As noted earlier, the premium decrease in the ETH line
of business was the result of stricter underwriting criteria implemented for the 2008–2009 travel season designed
to improve the financial performance of this line of business. All other Niche Products’ lines of business
recorded significant growth in 2008 compared to 2007 and management continues to view this division as a
primary source of growth for EGI.
Net written premiums increased $11.6 million or 7.9% to $158.1 million for the year ended December 31,
2008, compared to $146.5 million for the same period last year. The increase in net written premiums was
consistent with the percentage increase in gross written premiums noted above.
Management’s Discussion and Analysis 2008
Earned Premiums
Net earned premiums for 2008, were $157.3 million, an increase of $37.7 million or 31.5% from 2007. This
increase was higher than the increase in net written premiums of 7.9%, primarily due to the decline of written
premiums from the ETH line of business in 2008 compared to 2007. Since ETH premiums are mainly earned
during the winter months (December to March), relatively high written premiums from the 2007–2008 travel
season recorded in 2007, were earned in the first quarter of 2008. The decline in written premiums from this line
of business will not fully impact net earned premiums until the first half of 2009.
Incurred Claims Expense
Net incurred claims expense increased $34.6 million or 48.6% to $105.8 million for 2008, compared to $71.2
million for 2007. The resulting loss ratio of 67.3% for 2008, represents an increase of 7.8% over the 2007 loss
ratio of 59.5%. The loss ratio for each business segment increased in 2008, compared to 2007 for several reasons.
The Niche Products division’s loss ratio increased to 66% for the year compared to 56.1% in 2007. This
result was caused primarily by adverse claims experience in the ETH line of business for the 2007–2008 travel
season. The loss ratio reflected in the 2008 results for this travel season was 99.2% on net earned premiums of
$17.2 million. Partially offsetting this result was the loss ratio from all other Niche Products programs of 45.1%
which slightly exceeded EGI’s expectations
The Personal Lines division incurred a loss ratio of 65.6% in 2008 compared to 59.1% in 2007. This increase
was primarily attributable to a decrease in the favourable development of prior year claims recorded for this
business segment in 2008 compared to 2007. Positive development continued in 2008, resulting in the release of
$4.7 million of net reserves, compared to $10.7 million for 2007. Excluding the decrease in favourable
development in 2008, the net loss ratio of 70% compares favourably to 72.1% in 2007.
The 2008 loss ratio for the International division was 85.7% compared to the 2007 loss ratio of 73.9%. The
2008 result was adversely impacted by unfavourable development of 2007 accident year claims of $1.0 million
and a 2008 current year loss ratio of 77.0%. As previously noted, the reinsurance arrangements in place in the
International division have either been cancelled effective December 31, 2008, or are in the process of being
cancelled in 2009.
On a Company-wide consolidated basis, net favourable development of prior year claims of $5.1 million was
recorded in 2008 compared to favourable development of $11.8 million in 2007.
Acquisition Costs
Net acquisition costs, consisting mainly of commissions and premium taxes, increased $10.9 million or
41.8% to $37.0 million for 2008, compared to $26.1 million in 2007. This increase, compared to 2007 and in
relation to the increase in net earned premiums of 31.5%, was due to the higher proportion of Niche business
compared to Personal Lines business in 2008, attracting higher acquisition expenses.
Operating Expenses
Operating expenses, excluding interest expense in 2008, increased $2.2 million or 18.3% to $14.2 million for
2008, compared to $12.0 million for 2007. This increase was lower than the 31.5% increase in net earned
premiums noted above, which is partially the result of an improvement in economies of scale caused by an
increase in 2008 in ETH net earned premiums relative to written premiums.
29
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Underwriting Income
Underwriting results reflect the revenues from net earned premiums less claims, acquisition and operating
expenses. The overall underwriting income decreased $10 million to $0.2 million for the year ended December
31, 2008 compared to $10.2 million for 2007. The underwriting income for 2008 and 2007 was net of $1.3
million and $0.9 million of corporate and other expenses, respectively. The increase in corporate and other
expenses in 2008 was due to expenses associated with potential acquisition reviews during the year.
Underwriting income from the Personal Lines division for the year ended December 31, 2008 was $7.1
million, representing a decline of $3.5 million compared to an income of $10.6 million for 2007. This result was
due to an increase in the combined ratio to 92.9% in 2008 compared to 87.8% in 2007.
The underwriting loss from the Niche Products division for the year ended December 31, 2008 was $3.2
million, compared to an income of $0.3 million in 2007. This result was primarily due to the increase in the loss
ratio caused by adverse claims experience in the ETH line of business which resulted in an increase in the
combined ratio to 106.9% in 2008 compared to 98.8% in 2007.
The International division incurred an underwriting loss of $2.4 million, which includes expenses from EGI
Insurance Services, Inc., compared to a breakeven in 2007. As noted earlier, this result was caused by adverse
claims experience from assumed premium reinsurance contracts. The combined ratio for this business segment
increased to 119.1% in 2008 compared to 100.2% in 2007.
Investment Income
Investment income decreased $3.0 million, or 23.0%, to $10.0 million in 2008 compared to $13.0 million
in 2007.
The decrease in investment income compared to 2007 resulted from net losses recorded in 2008 on the sale of
investments and recording of investment impairments as at December 31, 2008. Net losses on investments
totaled $4.8 million in 2008, consisting of $0.1 million in net realized losses on the sale of investments and $4.7
million of investment impairments recorded at year-end, due to evidence of other-than-temporary fair value
deficiencies on specific investments. This result compares to net realized gains on disposal of investments of
$3.4 million earned in 2007. Partially offsetting the net losses on investments in 2008 were foreign exchange
gains of $2.7 million derived from funds held in U.S. currency and the impact of the weakened Canadian dollar.
Income from interest and dividends increased to $12.1 million in 2008 compared to $9.8 million in 2007. The
increase resulted from an increase in total invested assets to $259.8 million, on a fair value basis, as at December 31,
2008 compared to $238.3 million as at year end 2007. A significant portion of the increase in invested assets was
related to funds raised of $20.8 million pursuant to completion of EGI’s rights offering in July 2008.
Interest Expense
During 2008, interest expense related to bank indebtedness of $1.2 million was incurred compared to $0.3
million in 2007. In October 2007, EGI entered into a non-revolving term loan facility with a major Canadian bank
in the amount of $19.5 million. During the three-year term of the facility, interest of 6.2% was paid quarterly.
Net Income before Income Taxes
Net income before income taxes decreased $13.9 million, or 60.7%, to $9.0 million for 2008 compared to
$22.9 million for 2007 as the result of a higher combined ratio and the decline in investment income.
For the year ended December 31, 2008, underwriting income of $0.2 million plus investment income of $10.0
million, reduced by interest expenses on bank indebtedness of $1.2 million, comprised net income before income
Management’s Discussion and Analysis 2008
taxes of $9.0 million. This is compared to an underwriting income of $10.2 million plus investment income of
$13.0 million, reduced by interest expense of $0.3 million in 2007.
Income Taxes
The provision for income taxes for the year ended December 31, 2008 was $3.0 million compared to $7.9
million for 2007. This reflected lower pre-tax income as a result of lower underwriting profits and lower
investment income year over year. The approximate effective tax rate decreased to 33% for 2008 compared to
34% for the previous year, primarily due to the decline in the federal corporate income tax rate to 19.5% in 2008
from 22.1% in 2007.
Net Operating Income
Net operating income decreased $3.7 million to $9.1 million in 2008 from $13.0 million in 2007. Net
operating income excludes the after-tax impact of net realized losses and impairments on investments totaling
$3.2 million from net income in 2008. In 2007, net income was reduced by $2.2 million, the after-tax realized
gains recorded in the year.
YEAR ENDED DECEMBER 31, 2007 COMPARED TO 2006
The following financial information compares results for the full year 2007 and 2006.
($ THOUSANDS) 2007 2006
Variance
$
Variance
%
Direct written premiums 157,935 117,834 40,101 34.0 Net written premiums 146,511 106,047 40,464 38.2 Net earned premiums 119,606 103,942 15,664 15.1 Claims incurred 71,179 59,503 11,676 19.6 Acquisition costs 26,143 19,499 6,644 34.1 Operating expenses 12,043 10,431 1,612 15.5 Underwriting income (loss) 10,241 14,510 (4,268) (29.4) Investment income (loss) 12,954 11,033 1,920 17.4 Interest expense 259 – 259 – Net income (loss) before income taxes 22,936 25,543 (2,607) (10.2) Income taxes 7,871 8,562 (691) (8.1) Net income (loss) 15,065 16,981 (1,916) (11.3)
Net operating income 12,957 15,302 (2,345) (15.3)
Insurance Operation
Written Premiums
Direct written and assumed premiums increased $40.1 million or 34.0% to $157.9 million in 2007 compared
to $117.8 million for 2006. A significant increase was achieved in both business segments. The increase in
Personal Lines premiums was primarily the result of EGI’s entry into the U.S. non-standard auto insurance
market, effective January 1, 2007 through a reinsurance arrangement with AssuranceAmerica. The Company’s
Niche Products division continued to record significant premium growth in 2007, maintaining our track record of
steady growth in this business segment. The increase in premiums generated by the Personal Lines division was
achieved despite continued competitive pressures from standard auto insurers continuing to pursue what had been
31
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
traditionally perceived as non-standard risks. Offsetting the shrinkage in the Ontario non-standard auto business
was the premium growth achieved in assumed business from the U.S.-based quota share treaty participation, an
increase in Ontario motorcycle premiums and increases in Quebec’s automobile business. Automobile insurance
premiums in Quebec grew 42.1% to $9.1 million in 2007, compared to $6.4 million in 2006. Quebec is viewed as
a strategic growth area for geographic diversification with a focus on contracting new brokers and introducing
new products such as the motorcycle program. Under an exclusive arrangement with a specialist broker, EGI
began writing motorcycle business in Ontario during the first quarter of 2006. During 2007, direct premiums
from this jurisdiction totaled $13.9 million compared to $7.6 million in 2006.
Direct written premiums for the Niche Products division increased 142% to $48.1 million for in 2007,
compared to $19.9 million in 2006. Formed in 2003, the Niche Products division experienced significant growth
in the prior three years due to continued marketing efforts.
Net written premiums increased $40.5 million, or 38.2% to $146.5 million in 2007, compared to $106 million
for the prior year. The increase in net written premiums was consistent with the percentage increase in gross
written premiums noted above.
Earned Premiums
Net earned premiums for 2007, were $119.6 million, an increase of $15.7 million or 15.1% from 2006. This
increase was significantly lower than the net written premiums increase due to the impact of significant ETH
premiums, written primarily in the fourth quarter of 2007, the majority of which was not earned until the first half
of 2008.
Incurred Claims Expense
Net incurred claims expense increased $11.7 million or 19.7% to $71.2 million in 2007, compared to $59.5
million in 2006. The resulting 2007 loss ratio of 59.5% represented an increase of 2.3% over the 2006 year loss
ratio of 57.2%. As noted in the analysis above for the fourth quarter of 2007, the primary reason for the increase
in the 2007 loss ratio was an increase in the Niche Products division’s loss ratio to 56.1% for the year. ETH
recorded a loss ratio of 94% while all other Niche Products programs recorded an excellent 48% loss ratio in
2007. The Personal Lines division incurred a loss ratio of 60.4% in 2007 compared to 57.9% in 2006. This
increase was attributed to a higher than expected loss ratio in the motorcycle line of business of 76.6%. EGI
entered the Ontario motorcycle insurance market in 2006, and as this relatively new line of business grows and
matures, loss ratios are expected to decline.
Positive development of prior year claims continued in 2007, resulting in a release of $11.8 million of net
reserves that were accrued for the prior accident years. The favourable development can be distributed as $6.7
million for liability claims, $3.2 million for accident benefits claims, and $1.9 million for all other lines of
business. In 2006, favourable prior year claims development of $12.0 million was recorded.
Acquisition Costs
Net acquisition costs, which consist mainly of commissions and premium taxes, increased $6.6 million or
33.8% to $26.1 million in 2007, compared to $19.5 million in 2006. This increase, in relation to the increase in
net earned premiums of 15.1% compared to 2006, was the result of the reduction in the sliding scale reinsurance
commission adjustments recorded in 2007 compared to the prior year. Additional reinsurance commission of
$0.6 million was recorded in 2007 related to the 2005 policy year, compared to $2.7 million in 2006.
Management’s Discussion and Analysis 2008
Operating Expenses
Operating expenses, which include interest expense, increased $1.6 million or 13.3% to $12.0 million for
2007 compared to $10.4 million for 2006. The increase was primarily due to (1) an increase in employee salaries
and benefits of $1.37 million due to head count growth; (2) an accrual of rent and operating costs of $280,000
associated with EGI’s intention to relocate in 2008; and (3) expenses of $165,000 incurred in our new U.S.
subsidiary, EGI Insurance Services, Inc.
Underwriting Income
Underwriting results reflect the revenues from net earned premiums less claims, acquisition and operating
expenses. The overall underwriting income decreased $4.3 million to $10.2 million for 2007 compared to $14.5
million for 2006. The underwriting income for 2007 and 2006 was net of $0.9 million and $0.9 million of
corporate and other expenses, respectively.
Underwriting income from the Personal Lines division in 2007 was $10.8 million, representing a decline of
$4.3 million compared to an income of $15.1 million for 2006. This result was due to an increase in the
combined ratio to 87.8% in 2007 compared to 83.4% in 2006.
The 2007 results include the release of actuarial reserves for prior accident years’ claims of $11.8 million
compared to a release of $12.0 million in 2006, both the result of positive claims development related to prior
year reserves.
Underwriting income from the Niche Products division for 2007 was $0.3 million, a slight increase of $0.1
million compared to an income of $0.2 million in 2006. This result was achieved despite the adverse loss ratio
experienced in the ETH business and allocation of shared services expenses to this division in 2007 of $0.7
million. Allocation of shared expenses commenced in 2007.
Investment Income
Investment income increased $1.9 million, or 17.2%, to $12.9 million for 2007 compared to $11.0 million
for 2006.
The significant increase in investment income compared to 2006 resulted from two primary factors. EGI’s
investment portfolio reflected a $57.3 million or 25.6% increase in fair value as at December 31, 2007 compared
to 2006, due to positive cash flows from operations during the period. There was also an increase in realized
gains recorded in 2007 to $3.4 million, compared to $2.6 million of realized gains in 2006. The gains were
derived from the sale of investments totaling $204.1 million in 2007 and $169.7 million in 2006.
Note that a significant portion of the increase in the investment portfolio in 2007, compared to 2006, resulted
from the additional funds drawn from the credit facility of $19.6 million, established in October 2007, arranged to
fund U.S. business expansion.
Net Income before Income Taxes
Net income before income taxes decreased $2.6 million, or 10.2%, to $22.9 million for 2007, compared to $25.5
million for 2006, as a result of a higher combined ratio partially offset by the increase in investment income.
For 2007, underwriting income of $10.2 million plus investment income of $12.9 million minus interest
expense of $0.2 million, comprised net income before income taxes of $22.9 million. This compared to an
underwriting income of $14.5 million plus investment income of $11.0 million in 2006.
33
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Income Taxes
The provision for income taxes for the year ended December 31, 2007 was $7.9 million compared to $8.6
million for 2006. This reflected lower pre-tax income as a result of lower underwriting profits and increased
investment income year over year. The approximate effective tax rate was 34% for 2007 and 2006.
BALANCE SHEET ANALYSIS
Investments
EGI has an investment policy that seeks to provide a stable income base to support EGI’s liabilities without
incurring an undue level of investment risk. All investment decisions are made with this risk-return trade off in
mind. The two most important methods used to reduce the level of risk without reducing the rate of return in
EGI’s portfolio are diversification and the use of proven investment professionals.
EGI’s Board of Directors has established an Investment Committee to develop and implement detailed
strategies consistent with EGI’s objectives and to report regularly to the Board of Directors on its activities. EGI
has outsourced all buy/sell decisions on individual securities to a small number of reputable professional
investment managers. Using the “prudent person” approach, the Investment Committee monitors the
performance of each manager, measuring his or her performance against an appropriate market index benchmark.
Each of EGI’s investment managers operates under an investment management agreement which provides the
investment manager with a discretionary mandate to hold one or more types of securities and/or cash. The
investment manager receives an annual fee (payable quarterly) based on a negotiated percentage of the market
value of the portfolio being managed. The investment manager’s engagement is subject to immediate
cancellation by EGI, without penalty, upon giving written notice.
EGI’s investment portfolio is invested in well-established, active and liquid markets in Canada and the United
States. Fair value for most investments is determined by reference to quoted market prices. The external
investment managers invest on a total return basis, viewing realized gains and losses as important and recurring
components of the return on investments and, consequently, of income. The timing of the realization of gains and
losses may be unpredictable, and changes in the overall levels of fixed income or equity markets generally result
in corresponding changes in realized gains and losses.
To assess impairments, the Investment Committee and management review all holdings with a fair value
below their carrying values and, in consultation with the appropriate investment manager, ascertain whether the
carrying amounts are expected to be recovered. EGI’s investment managers provide advice as to whether the fair
value of these securities is adversely affected on an other than temporary basis. Based on this advice and other
factors, including the significant equity market decline in the last half of 2008 and uncertainty regarding its
recovery, EGI recorded investment impairments of $4.7 million as at December 31, 2008.
Management’s Discussion and Analysis 2008
Fair Value of Investments
The following table provides a comparison as at December 31, 2008 and December 31, 2007:
As at December 31
2008 2007
($ THOUSANDS) Fair value Fair value
BondsCanadian
Federal $ 82,078 $ 80,378 Provincial 45,162 30,948 Municipal 6,935 3,908
Corporate 86,570 67,864
220,745 183,098
United States Federal – 2,288
Corporate 2,717 666
2,717 2,954
Total Bonds 223,462 186,052
Preferred shares 4,042 6,106
Common shares Canadian 29,049 42,150
United States 1,178 2,244
30,227 44,394
Investment income due and accrued 2,043 1,758
$259,774 $238,310
EGI’s portfolio is constructed in a manner that seeks to ensure that its objectives of producing a competitive
rate of return are met, while at the same time protecting and enhancing statutory underwriting capital on a long-
term basis. This is achieved through diversification principles that ensure each asset class has limited exposure by
region, industry, issuer and type of underlying security. Target ranges are set for each asset class and economic
sector and are monitored by the Investment Committee to ensure that EGI’s investment managers comply with
these guidelines. All regulatory requirements and liquidity needs are adhered to by each manager.
Impaired Assets and Provisions for Losses
The Board of Directors has established a policy to write down or make a provision for any investment with
other-than-temporary impairment.
Management has reviewed currently available information regarding those investments whose estimated fair
values are less than carrying values. For those securities whose decline in fair value was considered to be other-
than-temporary, the Company has recorded the difference between the cost of the investment and its fair value as
an impairment which reduces investment income in the year recorded.
The Company considers an impairment to be other-than-temporary if it is unlikely the Company will recover
an investment’s amortized cost in a reasonable period of time. Factors considered by the Company include but
are not limited to the impact of issuer and industry specific events, current and expected future market and
economic conditions, the nature of the investment, and the severity and duration of the fair value deficiency.
35
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
An impairment loss of $4,713, comprised of $4,326 of common shares and $387 of Canadian corporate
bonds, has been recognized in net income during 2008. No provisions were recorded in 2007.
A remaining gross unrealized loss of $14,757 on investments held as at December 31, 2008, is recorded, net
of tax, in the amount of $9,887 in Accumulated Other Comprehensive Loss. The Company has concluded, based
on its review, that these fair value deficiencies are considered temporary in nature and they will be monitored on
an ongoing basis.
Fixed Income Securities
EGI holds fixed income securities to provide a steady, predictable level of income and reasonable liquidity
with minimum risk of loss and a fixed sum at maturity. EGI’s portfolio is diversified by selecting various types
of government and corporate bonds. Constraints on types of issuers take liquidity, diversification and risk into
account by limiting the portfolio mix by issuer.
EGI maintains a high overall credit quality level as measured by Dominion Bond Rating Service (DBRS).
Constraints are placed on the percentage of bonds which can be held in the rating classes as follows: Class A or
better – no maximum; Class BBB or lower – maximum 10%. EGI’s policy is to purchase only corporate bond
issues which are rated BBB or better at the time of purchase. In the event of subsequent downgrades, the
Investment Committee will consider whether to continue to hold the bonds.
The following table sets forth EGI’s fixed income portfolio by credit quality according to DBRS as at
December 31, 2008 and 2007.
Fixed Income Portfolio
As at December 31
2008 2007
($ THOUSANDS) Fair value % of
Fair value Fair value % of
Fair value
AAA $107,830 48 $100,388 54AA 60,713 27 43,015 23A 48,080 22 37,631 20BBB 6,765 3 5,018 3
CCC 74 – – –
Total $223,462 100 $186,052 100
Common Shares
Common shares are a key component of EGI’s portfolio to enhance the capital appreciation opportunities of
EGI’s invested assets. Using a conservative approach to equity selection, EGI’s investment managers ensure that
equities of companies with a reputation for strong management and a proven track record of success are selected
for EGI’s portfolio. Diversification by country and industry sector also reduces the overall risk level inherent in
EGI’s common share portfolio.
EGI generally limits its total exposure to common shares at any one time to a maximum of 16% of the total of
its invested assets and premium financing receivables, which is slightly below the average exposure to equities
for Canadian-owned P&C insurers.
Management’s Discussion and Analysis 2008
Canadian Common Share Portfolio
Included in the common shares held by the Company, as at December 31, 2007, was an investment in
Gladiator LP, managed by Savoy Capital, with a fair value of $1.2 million. In August 2006, as noted in our 2007
annual report, subsequent to a notice provided by Savoy to terminate the investment management services
agreement with the Gladiator fund, Savoy ceased actively investing in the fund and immediately began to employ
a defensive position. Equity exposures were reduced significantly and the cash position increased.
Since that time, the process to wind up the fund has been completed resulting in total cash redemptions
received by EGI of $8.2 million, of which $1.4 million was received in 2008, resulting in a small realized gain
recorded in 2008 related to the final wind up of the fund. EGI had no further exposure related to this fund as at
December 31, 2008.
Restrictions as to the amount of common shares held in any industry sector are also part of EGI’s risk
diversification methodology. The following table outlines EGI’s Canadian common share exposure to industry
sectors as at December 31, 2008 and 2007.
As at December 31
2008 2007
($ THOUSANDS)
Fair value and
carrying
amount
% of
fair
value
Fair value and
carrying
amount
% of
fair
value
Energy 5,513 19 7,736 18Financial services 9,173 32 14,275 34Materials 4,105 14 4,852 11Gladiator LP – – 1,238 3Other 10,258 35 14,049 34
Total 29,049 100 42,150 100
Recoverable from Reinsurers
As at December 31
($ THOUSANDS) 2008 2007
Reinsurers’ share of unpaid claims $41,901 $48,461
Reinsurers’ share of unearned premiums 3,712 3,602
Total $45,613 $52,063
As at December 31, 2008, the amount recoverable from reinsurers decreased by $6.4 million, or 12.3%, to
$45.6 million from $52.0 million at December 31, 2007. The decrease was due to reduced reliance on
reinsurance particularly for the 2007 and 2008 policy years. All reinsurers, with balances due, have a rating of
B++ or above as determined by Standard &Poor’s and A.M. Best.
Accounts Receivable
As at December 31
($ THOUSANDS) 2008 2007
Premium financing receivables 20,615 19,569
Facility Association (87) (90)
Agents and brokers 6,949 5,807
Other 88 96
Total 27,565 25,382
37
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Premium financing receivables was the largest component of this asset as at December 31, 2008 and
represents approximately 75.0% or $20.6 million of total receivables. Premium financing receivables increased
to $20.6 million at December 31, 2008, from $19.6 million at December 31, 2007. The majority of the
automobile business is billed directly to policyholders and remitted on a monthly basis.
Agent and broker receivables grew by 19% in 2008 compared to 2007, largely due to the significant growth
in the Niche business segment. EGI also experienced significant growth in business in Quebec where broker
billing is offered as a mode of payment.
Provision for Unpaid Claims
EGI establishes loss reserves to provide for future amounts required to pay claims related to insured events
that have occurred and been reported but have not yet been settled, as well as for those related to events that have
occurred but have not yet been reported to the insurer. Claims provisions (i.e. reserves for claims liability) are
established at the individual file level by the “case method” as claims are reported. The provisions are
subsequently adjusted as additional information affecting the estimated amount of a claim becomes known during
the course of its settlement. With the assistance of EGI’s consulting actuary, a reserve provision is also made for
management’s calculation of factors affecting the future development of claims, including a provision for IBNR
claims, based on the volume of business currently in force and the historical experience on claims. Reserves are
also established for the estimated internal and external loss adjustment expenses which will be incurred during the
claims settlement process.
The provision for unpaid claims and adjustment expenses is discounted to take into account the time value of
money as required by EGI’s primary insurance regulator. It also includes a provision for adverse deviation as
required by accepted Canadian actuarial practice. EGI’s consulting actuary reports on the adequacy of EGI’s
claims reserves on a quarterly basis. As time passes, more information about the claims becomes known and
provisional estimates are appropriately adjusted upward or downward. Adjustments to reserves are reflected in
the results of operations in the periods in which the estimates are changed.
The development of the provision for claims is shown by the difference between estimates of reserves as of the
initial year-end and the re-estimated liability at each subsequent year-end. This is based on actual payments in full or
partial settlement of claims, plus re-estimates of the reserves required for claims still open or claims still unreported.
Favourable development means that the original reserve estimates were higher than subsequently indicated.
Unfavourable development means that the original reserve estimates were lower than subsequently indicated.
For further discussion of EGI’s reserving methods and underlying assumptions, see “Critical Accounting
Estimates and Assumptions – Policy Liabilities”.
Provision for unpaid claims consists of the gross amount of individual case reserves established and
management’s estimate of claims incurred, but not reported, based on the volume of business currently in force
and historical claims experience. In order to ensure that EGI’s provision for unpaid claims (often called
“reserves”) is adequate, management has retained the services of an independent consulting actuary. EGI strives
to establish adequate provisions at each quarter-end.
EGI estimates its reserves on a quarterly basis and this is supported by quarterly assessments by the
independent consulting actuary. Every quarter, for each line of business, EGI compares actual and expected
claims development. To the extent that actual results differ from expected development, assumptions are re-
evaluated and new estimates are derived. Although EGI believes its overall provision levels to be adequate to
satisfy its obligations under existing policies, actual losses may deviate, perhaps substantially, from the amounts
Management’s Discussion and Analysis 2008
reflected in EGI’s financial statements. To the extent provisions prove to be inadequate, EGI would have to
increase such provisions and incur a charge to earnings in the future.
The table below shows the development of the provision for claims reserves including loss adjustment
expenses as at December 31 in each year of the five-year period and for the year ended December 31, 2008, for
Echelon (on a 100% basis).
Year ended December 31
($ THOUSANDS) 2007 2006 2005 2004 2003
Reserve carried (actuarial present value basis) (1) 168,257 145,691 129,041 107,196 79,191
Reserve at December 31, 2003
Cumulative paid to December 31, 2003
Cumulative redundancy (deficiency)
Reserve at December 31, 2004 56,226
Cumulative paid to December 31, 2004 24,184
Cumulative redundancy (deficiency) (1,219)
Reserve at December 31, 2005 70,620 37,802
Cumulative paid to December 31, 2005 24,922 38,802
Cumulative redundancy (deficiency) 11,654 2,587
Reserve at December 31, 2006 88,029 49,557 25,214
Cumulative paid to December 31, 2006 25,817 41,158 49,592
Cumulative redundancy (deficiency) 15,195 16,481 4,385
Reserve at December 31, 2007 107,992 67,408 36,129 17,569
Cumulative paid to December 31, 2007 30,432 46,413 55,306 28,217
Cumulative redundancy (deficiency) 7,267 15,220 15,761 3,405
Reserve at December 31, 2008 117,541 81,172 50,013 25,237 12,112
Cumulative paid to December 31, 2008 44,265 53,325 62,210 66,181 64,392
Cumulative redundancy (deficiency) 6,450 11,194 16,818 15,778 2,687
(1) Amounts include provision for adverse deviation (PFAD) of $17,401 for 2007; $14,756 for 2006; $12,473 for 2005;
$8,613 for 2004; and $6,137 for 2003.
The uncertainties regarding EGI’s reserves could result in a liability exceeding the reserves by an amount that
would be material to EGI’s financial condition or results of operations in a future period. Future development
could be significantly different from the past, due to many unknown factors (see “Risk Factors”).
Reinsurance
EGI has reinsurance treaties with several unaffiliated reinsurers, all of whom are selected on the basis of their
creditworthiness. EGI purchases reinsurance to reduce its exposure to the insurance risks that it assumes in
writing business. For 2008, the maximum net retention on a single risk was $1.5 million (2007 – $1.15 million).
In accordance with industry practice, EGI’s reinsurance recoverables with licensed Canadian reinsurers are
generally unsecured because Canadian regulations require these reinsurers to maintain minimum asset and capital
balances in Canada to meet their Canadian obligations. However, policy liabilities rank in priority to any
subordinate creditors a reinsurer may have. For reinsurance recoverables with non-licensed reinsurers, EGI
maintains security against reinsurance recoverables in the form of cash, letters of credit and/or assets held in trust
accounts. At December 31, 2008, EGI was the assigned beneficiary of such trust accounts totaling $2.3 million
(December 31, 2007 – $2.4 million) in guarantees from unlicensed reinsurers.
39
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Excess of loss and catastrophe reinsurance is used to limit an insurer’s exposure to a maximum dollar value
per claim and per occurrence. Quota share is a form of proportional reinsurance often used by an insurer to build
a book of business larger than can be supported by the insurer’s own capital. When used on established,
profitable lines of business, quota share is an expensive substitute for equity capital. The insurer is essentially
borrowing capital from the reinsurer by transferring unearned premium and claims liabilities from its books to the
books of the reinsurer. Within the range of expected loss ratios, this transfer is done at a direct cost to the insurer,
which happens through the ceding commission (expense allowance) paid by the reinsurer.
The ceding commission paid to the insurer by the reinsurer varies depending on the gross loss ratio. As the
gross loss ratio increases, the amount of ceding commission decreases, subject to agreed upon limits. Above the
maximum loss ratio on the ceding commission scale, there is full risk transfer (i.e. the potential to lose money) to
the reinsurer. Below the minimum loss ratio on the ceding commission scale, the reinsurer’s profit increases.
The reinsurer also retains the investment income on the cash balances that develop between the dates premiums
are received and the dates claims are paid.
EGI purchases renewable excess of loss and catastrophe reinsurance from third-party reinsurers, covering its
automobile and general liability business. In 2008, such coverage was for a total of $18.0 million, and $13.9
million in 2007. Other than general liability, coverages for the programs of the Niche Products division are
reinsured on a program-by-program basis.
For 2008, EGI’s liability after all reinsurance recoveries was limited to a maximum of $1.5 million, and in
2007, $1.15 million on any one claim. Using reinsurance, EGI’s policy is to limit its loss exposure in any one
claim to not more than 2% of its shareholders’ equity.
EGI depends upon the financial stability of its reinsurers in the same way that EGI’s insureds rely upon EGI.
Accordingly, EGI carefully selects its reinsurers and only deals with creditworthy reinsurers. EGI’s Reinsurance
Committee is responsible for evaluating and approving companies to which EGI cedes reinsurance. The
committee consults with AON Re Canada Inc. regarding the financial ratings of EGI’s reinsurers. Reinsurers are
selected based on their financial strength ratings, services, reputation and prices offered on the required
reinsurance. As reported to EGI by AON Re Canada Inc., EGI’s reinsurance broker, at December, 2008, all
reinsurers providing coverage under EGI’s treaties were rated B++ or better by A.M. Best.
As EGI’s insurance and reinsurance company subsidiaries increase their equity (and therefore regulatory capital),
they can retain more insurance business for their own account and therefore purchase less reinsurance. The marginal
return on this new capital can be very substantial. Each dollar of new equity allows EGI to retain up to two and one-
half dollars of additional premium (and the potential downside risk thereon) each year for its own account.
EGI believes that there is currently adequate reinsurance capacity in the marketplace for those classes of
business which EGI underwrites, and management is not aware of any developments that might cause a serious
shortage of capacity in the future. EGI believes that, through its reinsurance program, it is adequately protected
against major underwriting losses arising from a large claim under a single policy or claims under a group of
policies arising from a single event.
Share Capital
As of March 13, 2009, there were 11,687,582 common shares issued and outstanding. See also note 10 to the
consolidated financial statements.
Management’s Discussion and Analysis 2008
Liquidity and Capital Resources
The purpose of liquidity management is to ensure there is sufficient cash to meet all of EGI’s financial
commitments and obligations as they come due. The Company pays quarterly dividends to its common
shareholders. The dividend payment for the fourth quarter was made on December 29, 2008, to common
shareholders of record on December 12, 2008, in the amount of $0.7 million. EGI believes that it has the
flexibility to obtain, from internal sources, the funds needed to fulfill its cash requirements, including quarterly
dividend payment commitments to shareholders, during the following financial year and to satisfy regulatory
capital requirements. Despite recent global market events, including a material reduction in liquidity, EGI
believes that its liquidity and funding position remains adequate to execute its strategy. Additionally EGI has
been able to raise $20.8 million in net proceeds from a Rights Offering in July 2008 to supplement current
resources and further strengthen its liquidity position. EGI’s principal sources of funds are premiums collected,
investment income and proceeds from investments that have been sold or have matured. However, such funds
may not provide sufficient capital to enable EGI to pursue additional market opportunities.
In October 2007, EGI entered into a non-revolving term credit facility with a major Canadian bank in the
amount of US$20 million, converted to CDN$19.55 million, the equivalent Canadian dollar amount as of the
closing date. The facility bears interest of 6.2% which is payable monthly over the three-year term of the
agreement. After three years, EGI is obligated to repay the amounts drawn as at the termination of the agreement.
Pursuant to the credit facility agreement, EGI is required to comply with various financial covenants and financial
information reporting requirements.
During the three-year term, EGI has agreed to various financial covenants, of which the key ones require EGI
to maintain a minimum tangible net worth of $80.0 million and a maximum debt-to-capital ratio of 0.30:1.00.
The initial drawdown of US$20 million, or CDN$19.55 million, was used to increase the capital of CIM
Reinsurance Company Ltd., EGI’s Barbados-based reinsurance company, which has been used to reinsure
selected niche and specialty line insurers which underwrite business in the United States.
Contractual obligations include operating leases, for which $1.1 million was due in less than a year and $8.2
million is due over the next nine years. In addition, EGI has commitments under a contractual agreement with a
third party computer software provider totaling $4.4 million over the next three years. Under this agreement EGI
has retained the right to use an integrated insurance policy administration system which is expected to improve
operating efficiencies related to the administration of Personal Lines products.
EGI is primarily a holding company and, as such, has limited direct operations of its own. EGI’s principal
assets are the shares of its insurance, reinsurance and insurance management subsidiaries. Accordingly, its future
cash flows depend in part upon the availability of dividends and other statutorily permissible distributions from
the insurance subsidiaries. The ability to pay such dividends and to make such other distributions is limited by
applicable laws and regulations of the jurisdictions in which the insurance subsidiaries are domiciled, which
subject the insurance subsidiaries to significant regulatory restrictions. These laws and regulations require,
among other things, that the insurance subsidiaries maintain minimum solvency requirements and may also limit
the amount of dividends that the insurance subsidiaries can pay to EGI.
Transactions with Related Parties
EGI has entered into transactions with two related parties, The Co-operators Group Limited (Co-operators)
and Purves Redmond Limited (Purves Redmond). These transactions are carried out in the normal course of
operations and are measured at cost which approximates fair value. The transactions involving Co-operators,
41
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
which is a significant shareholder of EGI, principally consist of an agent distribution channel, support services
and investment management. Purves Redmond is involved in arranging insurance coverage for the companies
within the EGI group. Robert Purves, a shareholder and director of EGI, is also a shareholder and the chairman
of Purves Redmond.
Risk Management
EGI has developed a comprehensive process of risk management and internal control which emphasizes the
proactive identification of risks facing the organization and the effective management and control of these risks.
The foundation of the process is the ongoing thorough operational analysis by senior management committees
and a structured oversight process undertaken by the Board of Directors and appointed committees. Underlying
this structure are strong internal control procedures which are designed to safeguard EGI’s assets and protect the
organization and its stakeholders from risk.
As a provider of insurance products, effective risk management is fundamental to EGI’s ability to protect the
interests of EGI’s customers and shareholders. EGI is exposed to potential loss from various market risks, including
interest rate and equity market fluctuation risk, credit risk, liquidity risk and, to a lesser extent, foreign currency risk.
Market Risk
Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates,
foreign currency exchange rates, and other relevant market rate or price changes. Market risk is directly
influenced by the volatility and liquidity in the markets in which the related underlying assets are traded.
The primary market risk to the investment portfolio is the interest rate risk associated with investments in
fixed income securities. EGI’s exposure to unhedged foreign exchange risk is not significant and is limited to the
common equity portfolio.
For EGI’s investment portfolio, there were no significant changes in 2008 in the primary market risk
exposures or in how those exposures are managed compared to the year ended December 31, 2007. Management
does not currently anticipate significant changes in EGI’s primary market risk exposures or in how those
exposures are managed in future reporting periods based upon what is known or expected to be in effect in future
reporting periods.
Interest Rate and Equity Market Fluctuation
Movements in short and long-term interest rates, as well as fluctuations in the value of equity securities,
affect the level and timing of recognition of gains and losses on securities EGI holds, and cause changes in
realized and unrealized gains and losses. Generally, EGI investment income will be reduced during sustained
periods of lower interest rates as higher yielding fixed income securities are called, mature, or are sold and the
proceeds are reinvested at lower rates. During periods of rising interest rates, the market value of EGI’s existing
fixed income securities will generally decrease and the realized gains on fixed income securities will likely be
reduced. Realized losses will be incurred following significant increases in interest rates.
Generally, declining interest rates result in unrealized gains in the value of the fixed income securities EGI
continues to hold, as well as realized gains to the extent the relevant securities are sold. General economic
conditions, political conditions and many other factors can also adversely affect the stock markets and,
consequently, the value of the equity securities EGI owns.
Management’s Discussion and Analysis 2008
Credit Risk
Credit risk is the possibility that counterparties may not be able to meet payment obligations when they
become due. EGI assumes counterparty credit risk in many forms. A counter-party is any person or entity from
which cash or other forms of consideration are expected to extinguish a liability or obligation to EGI. The credit
risk exposure is concentrated primarily in the fixed income and preferred share investment portfolios and, to a
lesser extent, in reinsurance recoverables.
EGI’s risk management strategy and investment policy is to invest in debt instruments of high credit quality
issuers and to limit the amount of credit exposure with respect to any one issuer. EGI attempts to limit its credit
exposure by imposing fixed income portfolio limits on individual corporate issuers based upon credit quality (see
“Investments” – “Fixed Income Securities” and “Reinsurance” sections.
Foreign Exchange Risk
Foreign exchange risk is the possibility that changes in exchange rates may produce an unintended effect on
earnings and equity when measured in domestic currency. This risk is largest when asset backing liabilities are
payable in one currency and are invested in financial instruments of another currency.
EGI is exposed to some foreign exchange risk arising from claims on the ETH insurance business, the
investment in U.S. dollar denominated investments and business assumed from U.S.-domiciled insurers. Total
invested assets denominated in U.S. dollars were less than 3% of the total invested assets at December 31, 2008.
EGI’s general policy is to minimize foreign currency exposure by maintaining investments in the same currency
as the offsetting liabilities.
Risk Factors
Careful consideration should be given to the following factors, which must be read in conjunction with the
detailed information appearing elsewhere in this report. Any of the matters highlighted in these risk factors could
have a material adverse effect on EGI’s results of operations, business prospects or financial condition.
Nature of the Industry
The P&C insurance business in Canada is affected by many factors which can cause fluctuations in the results
of operations of EGI. Many of these factors are beyond EGI’s control. An economic downturn in those
jurisdictions in which EGI writes business could result in less demand for insurance and lower policy amounts.
As a property and casualty insurer, EGI is subject to claims arising out of catastrophes, which may have a
significant impact on its results of operations and financial condition. These factors, together with the industry’s
historically cyclical competitive pricing, could result in fluctuations in the underwriting results and net income of
EGI. A significant portion of the earnings of insurance companies is derived from the income from their
investment portfolios. EGI’s investment income will fluctuate depending on the returns and values of securities
in its investment portfolio.
Regulation
EGI is subject to the laws and regulations of the jurisdictions in which it carries on business. These laws and
regulations cover many aspects of its business, including premium rates for automobile insurance; the assets in
which it may invest; the levels of capital and surplus and the standards of solvency that it must maintain; and the
amount of dividends which it may declare and pay.
Changes to laws or regulations are impossible to predict and could materially adversely affect EGI’s business,
results of operations and financial condition. Where the Office of the Superintendent of Financial Institutions
(OSFI) is concerned about an unsafe course of conduct or an unsound practice in conducting the business of a
43
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
federally regulated insurance company, OSFI may direct the insurance company to refrain from a course of action or
to perform acts necessary to remedy the situation. In certain circumstances, OSFI may take control of the assets of
an insurance company or take control of the company itself. More restrictive laws, rules or regulations may be
adopted in the future that could make compliance more difficult and/or expensive. Specifically, recently adopted
legislation addressing privacy issues, among other matters, is expected to lead to additional regulation of the
insurance industry in the coming years, which could result in increased expenses or restrictions on EGI’s operations.
Industry Growth
EGI is subject to and dependent on fluctuations within the P&C insurance industry. According to Canadian
Underwriter, from 2001 to 2004, direct written premiums in the P&C insurance industry in Ontario, Alberta and
Quebec grew at an abnormally high compound annual growth rate of 12.3%. However, in 2005 and 2006, the
growth in direct written premiums slowed significantly to approximately 1%. EGI believes that soft market
conditions will continue in the short term and that the performance of the P&C insurance industry will trend
toward the industry’s historic norms.
Competition
The P&C insurance business is highly competitive with pricing being a primary means of competition. Other
elements of competition include availability and quality of products, quality and speed of service, financial
strength, distribution systems and technical expertise.
EGI competes with many other insurance companies. Certain of these competitors are larger and have greater
financial resources than EGI has.
In addition, certain competitors have from time to time decreased their prices in an apparent attempt to gain
market share.
As competitors introduce new products and as new competitors enter the market, the Company and its
insurance subsidiaries may encounter additional and more intense competition. There can be no assurance that
EGI will continue to increase revenues or be profitable. To a large degree, future revenues of EGI are dependent
upon its ability to continue to develop and market its products and to enhance the capabilities of its products to
meet changes in customer needs.
EGI expects to encounter competition from other entities having a business objective similar to that of EGI.
Many of these entities are well established and have extensive experience in connection with identifying and
effecting business acquisitions directly or through affiliates. Many of these competitors possess greater financial
resources, technical personnel and other resources than EGI and there can be no assurance that EGI will have the
ability to compete successfully. EGI’s financial resources will be relatively limited when contrasted with those of
many of its competitors. Although EGI’s business strategy assumes that the industry will generate competition,
there can be no assurance on how any level of competition may impact the future revenues of EGI.
Cyclicality
Historically, the results of companies in the P&C insurance industry have been subject to significant
fluctuations and uncertainties. The profitability of P&C insurers can be affected significantly by many factors,
including regulatory regimes, developing trends in tort and class action litigation, adoption of consumer initiatives
regarding rates or claims handling procedures, and privacy and consumer protection laws that prevent insurers
from assessing risk, or factors that have a high correlation with risks considered, such as credit scoring.
The financial performance of the P&C insurance industry has historically tended to fluctuate in cyclical
patterns of “soft” markets characterized generally by increased competition, resulting in lower premium rates and
Management’s Discussion and Analysis 2008
underwriting standards, followed by “hard” markets characterized generally by lessening competition, stricter
underwriting standards and increasing premium rates. EGI’s profitability tends to follow this cyclical market
pattern with profitability generally increasing in hard markets and decreasing in soft markets. These fluctuations
in demand and competition could produce underwriting results that would have a negative impact on EGI’s
results of operations and financial condition.
Unpredictable Catastrophic Events
Catastrophes can be caused by various natural and unnatural events. Natural catastrophic events include
hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires. Unnatural
catastrophic events include hostilities, terrorist acts, riots, crashes and derailments. The incidence and severity of
catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total
amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are
restricted to small geographic areas; however, hurricanes, windstorms and earthquakes may produce significant
damage in large, heavily populated areas. Catastrophes can cause losses in a variety of P&C insurance lines. For
example, the ice storm in eastern Canada in 1998 caused P&C insurance losses in several lines of business,
including business interruption, personal property, automobile and commercial property. Claims resulting from
natural or unnatural catastrophic events could cause substantial volatility in EGI’s financial results for any fiscal
quarter or year and could materially reduce EGI’s profitability or harm EGI’s financial condition. EGI’s ability to
write new business also could be affected. EGI may experience an abrupt interruption of activities caused by
unforeseeable and/or catastrophic events. EGI’s operations may be subject to losses resulting from such disruptions.
Losses can relate to property, financial assets, trading positions and also to key personnel. If EGI’s business
continuity plans cannot be put into action or do not take such events into account, losses may further increase.
Interest Rates
An increase in interest rates may result in lower values for EGI’s bond portfolio and increased costs of
borrowing for EGI on future debt instruments or credit facilities. Such increased costs would negatively affect
EGI’s operating results.
Negative Publicity in the Industry
EGI’s products and services are ultimately distributed to individual consumers. From time to time, consumer
advocacy groups or the media may focus attention on EGI’s products and services, thereby subjecting its industry
to periodic negative publicity. EGI also may be negatively impacted if its industry engages in practices resulting
in increased public attention to its business. Negative publicity may also result in increased regulation and
legislative scrutiny of practices in the P&C insurance industry as well as increased litigation. Such consequences
may increase EGI’s costs of doing business and adversely affect EGI’s profitability by impeding its ability to
market its products and services or increasing the regulatory burdens under which EGI operates.
Reliance on Brokers
EGI distributes its products primarily through a network of brokers. These brokers sell EGI’s competitors’
products and may stop selling EGI products altogether. Strong competition exists among insurers for brokers
with demonstrated ability to sell insurance products. Premium volume and profitability could be materially
adversely affected if there is a material decrease in the number of brokers that choose to sell EGI products. In
addition, some P&C insurance companies offer their products through dedicated, captive sales organizations. If
the number of such P&C insurance companies increases, EGI’s revenues may decrease, which could have a
material adverse effect on EGI’s business, financial condition and results of operations. EGI’s strategy of
distributing through Co-operators’ agent channel may also adversely impact its relationship with brokers who
distribute EGI products.
45
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Product and Pricing
EGI prices its products taking into account numerous factors, including claims frequency and severity trends,
product line expense ratios, special risk factors, the capital required to support the product line, and the
investment income earned on that capital. EGI’s pricing process is designed to ensure an appropriate return on
capital and long-term rate stability, avoiding wide fluctuations in rate unless necessary. These factors are
reviewed and adjusted periodically to ensure they reflect the current environment.
However, pricing for automobile insurance must be submitted to each provincial government regulator and in
certain provinces pre-approved by the regulator. It is possible that, in spite of EGI’s best efforts, regulator
decisions may impede automobile rate increases or other actions that EGI may wish to take. Also, during periods
of intense competition for any product line to gain market share, EGI’s competitors may price their products
below the rates EGI considers acceptable. Although EGI may adjust its pricing up or down to maintain EGI’s
competitive position, EGI strives to ensure its pricing will produce an appropriate return on invested capital.
There is no assurance that EGI will not lose market share during periods of intense pricing competition.
Underwriting and Claims
EGI is exposed to losses resulting from the underwriting of risks being insured and the exposure to financial
loss resulting from greater than anticipated adjudication, settlement and claims costs. EGI’s success depends
upon its ability to accurately assess the risks associated with the insurance policies that EGI writes.
EGI’s underwriting objectives are to develop business within EGI’s target markets on a prudent and
diversified basis and to achieve profitable underwriting results (i.e. a combined ratio below 100%). EGI
underwrites automobile business after a review of the applicant’s driving record reports and claims experience.
There can be no assurances that EGI will properly assess the risks associated with the insurance policies that it
writes and may, therefore, experience increased adjudication, settlement and claims costs.
Loss Reserves and Claims Management
The amounts established and to be established by EGI for loss and loss adjustment expense reserves are
estimates of future costs based on various assumptions, including actuarial projections of the cost of settlement
and the administration of claims, estimates of future trends in claims severity and frequency, and the level of
insurance fraud. Most or all of these factors are not directly quantifiable, particularly on a prospective basis, and
the effects of these and unforeseen factors could negatively impact EGI’s ability to accurately assess the risks of
the policies that it writes. In addition, future adjustments to loss reserves and loss adjustment expenses that are
unanticipated by management could have an adverse impact upon the financial condition and results of operations
of EGI. Although EGI’s management believes its overall reserve levels as at December 31, 2008 are adequate to
meet its obligations under existing policies, actual losses may deviate, perhaps substantially, from the reserves
reflected in EGI’s financial statements. To the extent reserves prove to be inadequate, EGI would have to
increase such reserves and incur a charge to earnings.
Errors and Omissions Claims
Where EGI acts as a licensed insurance agency, it is subject to claims and litigation in the ordinary course of
business resulting from alleged errors and omissions in placing insurance and handling claims. The placement of
insurance and the handling of claims involve substantial amounts of money. Since errors and omissions claims
against EGI may allege EGI’s potential liability for all or part of the amounts in question, claimants may seek
large damage awards and these claims can involve significant defense costs. Errors and omissions could include,
for example, EGI’s employees or sub-agents failing, whether negligently or intentionally, to place coverage or file
claims on behalf of customers, to appropriately and adequately disclose insurer fee arrangements to its customers,
Management’s Discussion and Analysis 2008
to provide insurance providers with complete and accurate information relating to the risks being insured or to
appropriately apply funds that it holds for its customers on a fiduciary basis. It is not always possible to prevent
or detect errors and omissions, and the precautions EGI takes may not be effective in all cases.
EGI’s business, financial condition and/or results may be negatively affected if in the future its errors and
omissions insurance proves to be inadequate or unavailable. In addition, errors and omissions claims may harm
EGI’s reputation or divert management resources away from operating the business.
Investments
EGI’s investment assets are exposed to any combination of risks related to interest rates, foreign exchange
rates and changing market values.
EGI’s investment portfolio consists of diversified investments in fixed-income securities and preferred and
common stocks. Investment returns and market values of investments fluctuate from time to time. A decline in
returns could reduce the overall profitability of EGI. A change in interest rates, market values or foreign
exchange rates may affect Echelon’s regulatory strength tests.
Reinsurance
Consistent with industry practice, EGI utilizes reinsurance to manage its claims exposure and diversifies its
business by types of insurance and geographic area. The availability and cost of reinsurance are subject to
prevailing market conditions that are generally beyond the control of EGI and may affect EGI’s level of business
and profitability. There can be no assurance that developments may not occur in the future which might cause a
shortage of reinsurance capacity in those classes of business which EGI underwrites, which could result in the
curtailment of issuing of policies in a certain line of business or containing limits above a certain size.
Reinsurer Credit Risk
EGI’s reinsurance arrangements are with a limited number of reinsurers. This reinsurance may cause an
adverse effect on EGI’s results of operations if one or more of its reinsurers are unable to meet its financial
obligations. Although all of its reinsurers were rated B++ or higher by A.M. Best at the time of entering into the
reinsurance arrangements, these ratings are subject to change and may be lowered.
Although reinsurance makes the assuming reinsurers liable to EGI to the extent of the risk each reinsurer
assumes, EGI is not relieved of its primary liability to its insureds as the direct insurer. As a result, EGI bears
credit risk with respect to its reinsurers. EGI cannot ensure that its reinsurers will pay all reinsurance claims on a
timely basis or at all. EGI evaluates each reinsurance claim based on the facts of the case, historical experience
with the reinsurer on similar claims, and existing law and includes in its reserve for uncollectible reinsurance any
amounts deemed uncollectible. The inability to collect amounts due to EGI under reinsurance arrangements
would reduce EGI’s net income and cash flow.
Technology
EGI is heavily dependent on systems technology to process large volumes of transactions and there would be
a risk if the technology employed is inadequate or inappropriate to support current and future business needs and
objectives. EGI continues to implement new computer applications as part of a comprehensive approach to
improve systems technology. EGI regularly tests and improves its Business Recovery Emergency Plan to protect
itself, its producers and policyholders in the event of a technology failure; however, there is no assurance that EGI
will be able to respond to technology failures effectively and with minimal disruption.
47
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
Liquidity
EGI manages its cash and liquid assets in an effort to ensure there is sufficient cash to meet all of EGI’s
financial obligations as they fall due. As a federally regulated insurance company, Echelon is required to
maintain an asset base comprised of liquid securities that can be used to satisfy its ongoing commitments. EGI
believes that internally generated funds provide the financial flexibility needed to fulfill cash commitments on an
ongoing basis. EGI has no material commitments for capital expenditures. However, there can be no assurances
that EGI’s cash on hand and liquid assets will be sufficient to meet any future obligations that may come due.
Future Capital Requirements
EGI’s future capital requirements will depend upon many factors, including the expansion of EGI’s sales and
marketing efforts and the status of competition. There can be no assurance that any additional financing will be
available to EGI on acceptable terms, or at all. If additional funds are raised by issuing equity securities, further
dilution to the existing stockholders will result. If adequate funds are not available, EGI may be required to
delay, scale back or eliminate its programs. Accordingly, the inability to obtain such financing could have a
material adverse effect on EGI’s business, financial condition and results of operations.
Corporate Governance
Active oversight remains a priority for the Board of Directors. The board is directly involved, through its
committees, in overseeing all aspects of EGI’s operation. The objective of the board is to meet or exceed best
practices in corporate governance. There is independent oversight from the board and the respective committees
to key corporate functions such as financial reporting, compliance, risk assessment and management, as well as
human resources and succession planning.
EGI’s Board of Directors has established the following committees to ensure that risks are effectively
identified, monitored, controlled and reported on:
Audit and Risk Committee: This committee of directors of the Company reviews all financial information,
monitors internal controls and provides oversight of management’s risk control processes, specifically focusing
on financial related risks. Echelon also has an audit and risk committee of its directors in accordance with the
requirements of the Insurance Companies Act (Canada).
Conduct Review & Compensation Committee: The Conduct Review & Compensation Committee of
directors of the Company monitors related party transactions affecting EGI and reviews and approves officer
compensation and benefit plans. The Conduct Review Committee of directors of Echelon is responsible for the
identification and reporting of related party transactions to Echelon’s board of directors and the monitoring of
regulatory compliance and market conduct programs put in place by management to ensure their effectiveness.
Investment Committee: This committee, composed of directors and supported by senior executives, ensures
that risks associated with the investment of corporate and policyholder funds are effectively managed to
accomplish EGI’s investment objectives of prudent, conservative management of funds and compliance with
regulatory restrictions while achieving competitive rates of return.
Reinsurance Committee: This committee of senior executives works closely with AON Re Canada Inc.,
EGI’s reinsurance brokers, to ensure that effective reinsurance programs are in place, which facilitate the desired
growth of EGI’s business and provide EGI with protection against the occurrence of significant and unusual
claims risk and development.
Management’s Discussion and Analysis 2008
In addition to these committees, management has formed a number of working committees which have been
assigned the responsibility of identifying and managing specific corporate risks, including (i) a strategic initiatives
committee to consider the strategic risks faced by EGI; (ii) underwriting and claims committees to manage the risks
associated with the development and pricing of EGI’s products, claims adjudication and reserving; (iii) a technology
committee and a system prioritization committee to implement effective technology solutions; and (iv) a compliance
committee to ensure that the appropriate processes and procedures are in place to ensure compliance with all
applicable regulatory requirements. EGI has also established a Business Recovery Emergency Plan with the
objectives of protecting life, securing critical infrastructure and facilities from a catastrophic event and resuming
business operations in a timely effective manner thus minimizing loss to the organization.
EGI maintains liability insurance covering errors or omissions that may occur while acting in its role as an
insurance consultant. The annual premium for this coverage during fiscal 2008 was $5,031. This coverage has an
aggregate limit of liability of $2,000,000.
Controls and Procedures
Disclosure Controls and Procedures
Our disclosure controls and procedures are designed to provide reasonable assurance that information
required to be disclosed by EGI is recorded, processed, summarized and reported in a timely manner. This
includes controls and procedures that are designed to ensure that information is accumulated and communicated
to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosure.
As of December 31, 2008 an evaluation was carried out, under the supervision of the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as defined
under Multilateral Instrument 52-109. Based on that evaluation, the Chief Executive Officer and the Chief
Financial Officer concluded that the design of these disclosure controls and procedures was effective.
Internal Controls over Financial Reporting
As at the financial year ended December 31, 2008, the Chief Executive Officer and the Chief Financial
Officer evaluated the effectiveness of the Company’s internal control over financial reporting. Based on that
evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the internal control over
financial reporting was effective as at December 31, 2008, and provided reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance
with Canadian GAAP.
There have been no changes in the Company’s internal control over financial reporting during the year ended
December 31, 2008 that have materially affected or are reasonably likely to materially affect our internal control
over financial reporting.
Capital Resources
The total capitalization of EGI at December 31, 2008 was $118.6 million compared to $101.7 million at
December 31, 2007. The elements that increased shareholders’ equity consist of net income of $6.0 million, the
issuance of common shares for proceeds of $21.0 million and the cost of granting employee stock options of $0.2
million. These increases were offset by other comprehensive loss of $7.7 million in 2008, reflecting (i) a decline
in fair value of investments designated as available-for-sale investments of $10.6 million, net of income tax; (ii) a
reclassification for losses realized in 2008 of $3.1 million, net of income tax, and included in net income in the
year; and (iii) unrealized losses on translation of financial statements of self-sustaining foreign operations of $0.2
million and the payment of common share dividends of $2.6 million in 2008.
49
Management’s Discussion and Analysis 2008
EGI Financial Holdings Annual Report 2008
The continued growth in capitalization reflects the strengthening of EGI’s balance sheet and provides for
better capital adequacy as a property and casualty insurance underwriter. A common measure of capital adequacy
is the net written premium ratio to surplus (or common shareholders’ equity). This ratio was 1.33 as at December
31, 2008, compared to 1.44 in 2007. This level of leverage continues to be well below the 2.5:1 ratio which
management feels is fully leveraged capital. Therefore, EGI’s current capitalization provides it with adequate
financial resources for planned growth.
Shareholders’ Equity As at December 31
($ THOUSANDS) 2008 2007
Common shares 67,056 46,040
(11,676,282 shares) (9,682,152 shares)
Retained earnings 56,605 53,193
Contributed surplus 403 247
Accumulated other comprehensive income (loss) (5,460) 2,191
Total capitalization 118,604 101,671
Future Accounting Changes
International Financial Reporting Standards (IFRS)
During 2008, the Canadian Accounting Standards Board confirmed that publicly accountable enterprises will be
required to adopt International Financial Reporting Standards (IFRS) in place of Canadian GAAP for interim and
annual reporting purposes. The required changeover date is for fiscal years beginning on or after January 1, 2011.
The Company began its IFRS conversion process in 2008 and has established a project plan and governance
structure. The plan includes regular reporting to the Audit and Risk Committee of the Company’s Board of
Directors from the Project Management Committee which consists of members of Finance and IT, headed by the
Chief Financial Officer. The Company will be using an external advisor to assist in the conversion project, in
addition to receiving guidance from our external auditors.
The Company is currently engaged in the assessment and design phase of the project. This phase will involve
completion of a detailed diagnostic review to identify and assess the impact of IFRS differences in relation to
Canadian GAAP. In addition, an initial evaluation of IFRS 1 transition exemptions and an analysis of financial
systems will be performed.
On completion of the assessment and design phase, the Company will address the extent of financial and
operation system modifications required, plan the execution of further phases of the project, and develop solutions
to successfully complete implementation.
At this time, the impact, of the implementation of IFRS on the financial statements of the Company is not
reasonably determinable.
The Company will continue to report on the key elements and timing of our IFRS implementation plan in our
interim MD&As throughout 2009.
Management’s Discussion and Analysis 2008
GLOSSARY OF SELECTED INSURANCE TERMS
“Case method” means establishing a reserve liability equal to the most probable expected outcome for an individual claim.
“Cede” means the act of an insurer transferring or assigning part or all of the risk on an insurance policy written by it to a reinsurer by purchasing insurance from such reinsurer to cover the risk or part thereof.
“Combined ratio” of an insurer for any period means the sum of the loss ratio and the expense ratio of the insurer for such period.
“Direct written premiums” of an insurer for any period means the total premiums on insurance, including assumed reinsurance, written by the insurer during such period.
“Expense ratio” for any period means the sum of expenses, including commissions, premium taxes and operating expenses incurred, expressed as a percentage of net earned premiums.
“Facility Association” or “Facility” refers to an organization of the Canadian automobile insurance industry which exists to ensure that all drivers can obtain basic insurance, even if their application fails to meet the criteria of individualinsurance companies.
“Groupement” refers to a Quebec organization of the automobile insurance industry which exists to ensure that all drivers in Quebec can obtain basic insurance, even if their application fails to meet the criteria of individual insurance companies.
“Loss adjustment expenses” or “LAE” means the expense of settling claims, including certain legal and other fees and the expense of administering the claims adjustment process.
“Loss ratio” for any period means the sum of claims and claims adjustment expenses incurred, net of reinsurance, expressed as a percentage of net earned premiums.
“Minimum Capital Test” means the OSFI’s Minimum Capital Test Guideline under which a federally regulated insurer is measured for the adequacy of its capital.
“Net earned premiums” of an insurer means the portion of the written premium equal to the expired portion of the time for which insurance or reinsurance was in effect.
“Net written premiums” of an insurer means direct written premiums less amounts ceded to reinsurers.
“Producers” refers to, collectively, insurance brokers, agents and managing general agencies.
“Quota share” means a type of reinsurance where the reinsurer agrees to assume the risk on a fixed portion of a specified line of business in return for the same portion of the ceding company’s premium for that line of business.
“Reinsurance” means an arrangement in which an insurance company, the reinsurer, agrees to indemnify another insurance or reinsurance company, the ceding company, against all or a portion of the insurance or reinsurance risks underwritten by the ceding company under one or more policies.
“Retention” means the amount of liability for which an insurance company will be responsible after it has completed its reinsurance arrangements.
“Return on equity” or “ROE” for a period means net income expressed as a percentage of the average shareholders’ equity in that period.
“Risk” means a person or thing insured on an insurance policy.
“Underwriting” means the assumption of risk for designated loss or damage by issuing a policy of insurance in respect thereof.
“Unearned premiums” means the portion of premiums received relating to the period of risk in subsequent accounting periods and which is deferred to such subsequent accounting periods.
51
EGI Financial Holdings Annual Report 2008
Management’s Responsibility for Financial Reporting
Roles of Management, Board of Directors and Audit Committee
Management is responsible for the preparation and fair presentation of the consolidated financial statements, management’s discussion and analysis and other information in the annual report. The consolidated financial statements of EGI Financial Holdings Inc. (the Company) were prepared in accordance with Canadian generally accepted accounting principles. Where necessary, these consolidated financial statements reflect amounts based on the best estimates and judgment of management.
In meeting its responsibility for the reliability of the consolidated financial statements, management maintains the necessary system of internal controls. These controls are designed to provide management with reasonable assurance that the financial records are reliable for preparing consolidated financial statements and other financial information, assets are safeguarded against unauthorized use or disposition and liabilities are recognized. The Audit Committee, comprised of directors who are not officers or employees of the Company, meets, as required, with management, the Appointed Actuary and the external auditors to review actuarial, accounting, reporting and internal control matters. The Audit Committee is responsible for reviewing the consolidated financial statements and management’s discussion and analysis and recommending them to the Board of Directors for approval.
Role of Appointed Actuary
The actuary is appointed by the Board of Directors, pursuant to the Insurance Companies Act. The Appointed Actuary is responsible for ensuring that the assumptions and methods used in the valuation of policy liabilities are in accordance with accepted actuarial practice, applicable legislation and associated regulations or directives. The Appointed Actuary is also required to provide an opinion regarding the appropriateness of the policy liabilities at the consolidated balance sheet dates to meet all policyholder obligations of the Company. Examination of supporting data for accuracy and completeness and consideration of the Company’s assets are important elements of the work required to form this opinion. The Appointed Actuary uses the work of the external auditors in verifying data used for valuation purposes. Policy liabilities include unearned premiums, provision for unpaid claims, reinsurers’ share of unearned premiums and provision for unpaid claims and deferred policy acquisition costs.
Role of External Auditors
PricewaterhouseCoopers LLP, external auditors, have been appointed by the shareholders to conduct an independent audit of the consolidated financial statements of the Company in accordance with Canadian generally accepted auditing standards and report to the shareholders regarding the fairness of the annual consolidated financial statements. The external auditors consider the work of the Appointed Actuary in respect of policy liabilities included in the consolidated financial statements, on which the Appointed Actuary has rendered an opinion.
Toronto, Ontario February 23, 2009
Douglas E. McIntyre, Hemraj Singh, Chief Executive Officer Chief Financial Officer
APPOINTED ACTUARY'S REPORT
To the Shareholders of EGI Financial Holdings Inc.
I have valued the policy liabilities of the subsidiary insurance operations of EGI Financial Holdings Inc. in its consolidated balance sheets as at December 31, 2008 and 2007 in accordance with accepted actuarial practice, including the selection of appropriate assumptions and methods.
In my opinion, the amount of policy liabilities makes appropriate provision for all policyholder obligations and the consolidated balance sheets fairly present the results of the valuation.
__
_________Toronto, Ontario Joe S. Cheng, FCIA February 23, 2009 J. S. Cheng & Partners Inc.
February 23, 2009
Auditors’ Report
To the Shareholders of
EGI Financial Holdings Inc.
We have audited the consolidated balance sheets of EGI Financial Holdings Inc. as at December 31, 2008 and 2007 and the consolidated statements of income, changes in shareholders’ equity and comprehensive income and cash flows for the years then ended. These consolidated financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the company as at December 31, 2008 and 2007 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.
Chartered Accountants, Licensed Public Accountants
Toronto, Ontario
53
EGI FINANCIAL HOLDINGS INC. Consolidated Balance Sheets
(in $ thousands)
EGI Financial Holdings Annual Report 2008
AssetsDecember 31
2008December 31
2007
Cash and short-term deposits $ 29,111 $ 22,785
Investments (note 4) 259,774 238,310
Reinsurers’ share - unearned premiums (note 5) 3,712 3,602
- provision for unpaid claims (note 6) 41,901 48,461
Accounts receivable 27,565 25,382
Income taxes recoverable 7,202 3,278
Due from insurance companies 9,063 6,199
Deferred policy acquisition costs 14,703 15,530
Fixed assets (note 9) 2,372 1,250
Future income taxes (note 13) 3,172 2,674
Prepaid expenses and other assets 4,205 2,613
$402,780 $370,084
Liabilities
Bank indebtedness (note 14) $ 19,550 $ 19,550
Provision for unpaid claims (note 6) 185,255 169,091
Unearned premiums (note 5) 71,154 69,190
Unearned commission 363 291
Income taxes payable 429 –
Accounts payable and accrued liabilities 4,291 5,444
Payable to insurance companies 2,460 3,894
Other liabilities 674 953
284,176 268,413
Shareholders’ Equity
Share capital (note 10) 67,056 46,040
Contributed surplus (note 11) 403 247
Retained earnings 56,605 53,193
Accumulated other comprehensive (loss) income (5,460) 2,191
118,604 101,671
$402,780 $370,084
On Behalf of the Board of Directors:
Director Director
EGI FINANCIAL HOLDINGS INC. Consolidated Statements of Income
for the years ended December 31 (in $ thousands)
2008 2007
Revenue
Direct written and assumed premiums $170,730 $157,935
Net written and assumed premiums 158,107 146,511
Net earned premiums 157,255 119,606
Investment income (note 4) 10,009 12,954
167,264 132,560
Expenses
Incurred claims 105,837 71,179
Acquisition costs 37,026 26,143
Operating costs 14,229 12,043
Interest 1,216 259
158,308 109,624
Income before income taxes 8,956 22,936
Income tax expense (note 13) 2,977 7,871
Net income $ 5,979 $ 15,065
Earnings per share (note 19)
Net income per share - basic $ 0.57 $ 1.56
Net income per share - diluted $ 0.53 $ 1.45
55
EGI FINANCIAL HOLDINGS INC. Consolidated Statements of Changes in Shareholders’ Equity
and Comprehensive (Loss) Income for the years ended December 31
(in $ thousands)
EGI Financial Holdings Annual Report 2008
2008 2007Share capital
Balance, beginning of year $ 46,040 $ 45,833Common shares issued 21,016 207Balance, end of year 67,056 46,040
Contributed surplus
Balance, beginning of year 247 149Stock options - granted 186 123 - exercised (30) (25)Balance, end of year 403 247
Retained earnings
Balance, beginning of year 53,193 40,059Net income 5,979 15,065Dividends - Common shares (2,567) (1,931)Balance, end of year 56,605 53,193
Accumulated other comprehensive (loss) income
Balance beginning of year 2,191 –Transition adjustment - financial instruments – 5,301Other comprehensive (loss) (7,651) (3,110)Balance, end of year (5,460) 2,191
Shareholders’ equity, end of year $118,604 $101,671Comprehensive income
Net income $ 5,979 $ 15,065Other comprehensive loss, net of taxes Change in unrealized gains on available-for-sale securities:
Net unrealized gains (losses) on available-for-sale securities (10,618) (957)
Reclassification of net realized (gains) losses to net income 3,120 (2,153)
Unrealized losses on translation of financial statements of self-sustaining foreign operations (153) –Other comprehensive (loss) (7,651) (3,110)Total comprehensive (loss) income $ (1,672) $ 11,955
EGI FINANCIAL HOLDINGS INC. Consolidated Statements of Cash Flows
for the years ended December 31 (in $ thousands)
2008 2007
Cash provided by (used in): Operating activities
Net income $ 5,979 $15,065Items not involving cash
Amortization of fixed assets 674 406Amortization of premiums on bonds 501 368Realized losses (gains) on investments 4,833 (3,350)Increase in accrued investment income (285) (426)Other 186 123
11,888 12,186Cash flow from changes in
Reinsurers’ share of unearned premiums (110) 229Reinsurers’ share of unpaid claims 6,560 (76)Accounts receivable (2,183) (3,200)Income taxes recoverable (3,495) (2,706)Due from insurance companies (2,864) (2,203)Accounts payable and accrued liabilities (2,794) 590Provision for unpaid claims 16,164 22,990Unearned premiums 1,964 26,036Income taxes payable - (3,151)Future income taxes 2,988 547Prepaid expenses and other assets (1,592) (2,343)Deferred policy acquisition costs 827 (8,065)
27,353 40,834
Financing activities Increase in bank indebtedness – 19,550Issue of common shares 20,986 182Common share dividends (2,567) (1,931)
18,419 17,801
Investing activities Purchase of fixed assets (1,796) (857)Purchase of investments (249,873) (256,245)Sale/maturity of investments 212,223 204,099
(39,446) (53,003)
Increase in cash and short-term deposits $ 6,326 $ 5,632Cash and short-term deposits, beginning of year 22,785 17,153
Cash and short-term deposits, end of year $29,111 $22,785
Supplementary information Income taxes paid $ 9,021 $13,095Interest paid $ 1,209 $ 196
57
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
1 Organization and Basis of Presentation
EGI Financial Holdings Inc. (the Company or EGI) was incorporated on August 18, 1997 under
the Business Corporations Act (Ontario). The Company is principally engaged, through its
subsidiaries, in property and casualty insurance in Canada and the U.S.
The Company’s wholly-owned subsidiaries are EGI Insurance Managers Inc., Echelon General Insurance Company (Echelon), EGI Insurance Services, Inc., and CIM Reinsurance Company Ltd. (CIM Re).
The Company’s Barbados based subsidiary, CIM Re changed its functional currency to U.S. dollars effective January 1, 2008. CIM Re is operating as a self-sustaining foreign subsidiary and is therefore subject to foreign currency translation adjustments upon consolidation.
These consolidated financial statements include the accounts of the Company and its wholly
owned subsidiaries. All significant intercompany balances and transactions have been
eliminated upon consolidation.
2 Significant accounting changes
Capital Disclosures and Financial Instruments- Disclosures and Presentation
On January 1, 2008, the Company adopted three new accounting standards that were issued by
The Canadian Institute of Charted Accountants (CICA):
Handbook Section 1535, Capital Disclosures
Handbook Section 3862, Financial Instruments – Disclosure
Handbook Section 3863, Financial Instruments – Presentation
Section 1535 specifies the disclosure of (i) an entity’s objectives, policies and processes for
managing capital; (ii) quantitative data about what the entity regards as capital; (iii) whether the
entity has complied with any capital requirements; and (iv) if it has not complied, the
consequences of such non-compliance.
Sections 3862 and 3863 replaced Handbook Section 3861, Financial Instruments – Disclosure
and Presentation, revised and enhanced its disclosure requirements, and continued its
presentation requirements. These new sections place increased emphasis on disclosures about
the nature and extent of risks arising from financial instruments and how the entity manages
those risks.
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
3 Summary of significant accounting policies
These consolidated financial statements have been prepared in accordance with Canadian
generally accepted accounting principles. The preparation of consolidated financial statements
in accordance with Canadian generally accepted accounting principles requires management to
make estimates and assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the reporting date of the consolidated financial
statements. Estimates also affect the reported amounts of revenue and expenses for the
reporting period of the consolidated statements of income. Actual results could differ from those
estimates.
Cash and short-term deposits
Cash and short-term deposits include cash-on-hand, cash balances with banks and short term investments maturing in 90 days or less from the date of acquisition. These financial assets are classified as held-to-maturity assets and are recorded at an amortized cost which approximates fair value.
Investments
Investments are carried at fair value, which is the amount of consideration that would be agreed
upon in an arm’s-length transaction between knowledgeable, willing parties who are under no
compulsion to act. Fair values are determined by reference to quoted bid or asking prices, as
appropriate, in the most advantageous active market available. All investments are non-
derivatives and as such have all been classified as available-for-sale (AFS) investments.
Any change during the year in the fair values of investments classified as AFS are recognized in
Other Comprehensive Income (loss) (OCI). The cumulative change in the fair values of
investments previously recognized in Accumulated Other Comprehensive Income (loss) (AOCI)
are reclassified to Net Income when they are realized or the decline in value is considered to be
other than temporary.
Transaction costs related to AFS investments are capitalized on initial recognition and, where
applicable, are amortized to interest income using the effective yield method.
Investment income is recorded as it accrues. Dividend income on shares is accrued on the ex-dividend date. Gains and losses on disposal of investments are determined and recorded as at the transaction date and are calculated on the basis of the average cost of the investments held.
Provision for unpaid claims
Provision for unpaid claims includes adjustment expenses, which represent the estimated amounts required to settle all outstanding and unreported claims incurred to the end of the year. Unpaid claims liabilities are carried on an actuarial present value (APV) basis (discounted claims plus provisions for adverse deviations). Expected reinsurance recoveries on unpaid claims and adjustment expenses, net of any required provision for doubtful amounts, are
59
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
recognized as assets at the same time, using principles consistent with the Company’s method for establishing the related liability.
Reinsurance
The Company reflects third party reinsurance balances on the consolidated balance sheets on a gross basis to indicate the extent of credit risk related to third party reinsurance and its obligations to policyholders and on a net basis in the consolidated statements of income to indicate the results of the retention of premiums written.
Revenue recognition
Insurance premiums written are deferred as unearned premiums and taken into income pro rata primarily over the terms of the underlying policies. The portion of the premium related to the unexpired term of the policy at the end of the fiscal year is reflected in unearned premiums.
Deferred policy acquisition costs
Commissions and premium taxes incurred in the writing of premiums are deferred only to the
extent that they are expected to be recovered from unearned premiums and are amortized to
income over the terms of the related insurance policies. If unearned premiums are not sufficient
to pay expected claims and expenses, including policy maintenance expenses and unamortized
policy acquisition costs, a premium deficiency is said to exist. Premium deficiencies are
recognized initially by writing down deferred policy acquisition costs.
Fixed assets
Fixed assets are recorded at cost less accumulated amortization. Amortization is provided over the estimated useful lives of the assets using the straight-line method over the following terms:
Furniture and equipment 3 years
Computer hardware 3 years
Computer software 2 years
Employee benefits
The Company contributes to a group registered savings plan for employees as services are incurred. There are no other post-employment benefits.
Income taxes
The Company follows the asset and liability method of accounting for income taxes, whereby future income tax assets and liabilities are recognized for the future income tax consequences attributable to differences between the carrying amounts of existing assets and liabilities and their respective income tax bases and taxable losses and tax credit carry-forwards. Future income tax assets and liabilities are measured using enacted or substantively enacted income tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future income tax assets and liabilities of a change in income tax rates is recognized in income in the year that includes the date of
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
enactment or substantive enactment. Future tax assets are recognized to the extent the realization of such assets is more likely than not.
Foreign currency translation
Foreign currency transactions are translated into Canadian dollars using the exchange rates in effect at the date the transactions occurred. Monetary assets and liabilities are translated into Canadian dollars using the exchange rates in effect at the consolidated balance sheet dates. Exchange gains and losses are included in income, except unrealized gains or losses related to investments designated as AFS, which are recorded in AOCI.
Stock-based compensation
The Company has a stock option plan that is described in note 11. Stock options granted under
the plan are accounted for using the fair value method. Under this method, the compensation
cost of stock options granted is measured at estimated fair value at the grant date and
recognized over the vesting period.
4 Investments
The Company utilizes the prudent person approach to asset management, as required by the
Insurance Companies Act (the Act). An investment policy is in place and its application is
monitored by the Board of Directors. Diversification techniques are employed to minimize risk.
Policies limit investments in any entity or group of related entities to a maximum of 5% of the
Company’s assets. Limitations are also placed on the quality of investments, particularly
relating to investment grade bonds.
Fair value
The fair value of the investments is considered to be the quoted value, less transaction costs, based on bid prices determined by external pricing services. The majority of the investment portfolio is fully invested in well-established, active, liquid markets.
61
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
Fair value of investments
The following table provides a comparison as at December 31:
Available for sale 2008 2007
Carrying and fair value
Carrying and fair value
Bonds
Canadian Federal $ 82,078 $ 80,378 Provincial 45,162 30,948 Municipal 6,935 3,908 Corporate 86,570 67,864
220,745 183,098United States
Federal – 2,288 Corporate 2,717 666
2,717 2,954 Total bonds 223,462 186,052 Preferred shares 4,042 6,106 Common shares
Canadian 29,049 42,150 United States 1,178 2,244
30,227 44,394Investment income due and accrued 2,043 1,758
$259,774 $238,310
Impaired assets and provisions for losses
The Board of Directors has established a policy to write down or make a provision for any investment with other than temporary impairment.
Management has reviewed currently available information regarding those investments whose estimated fair values are less than carrying values. For those securities whose decline in fair value was other than temporary, the Company has recorded the difference between the cost of the investment and its fair value as an impairment which reduces investment income in the year recorded.
The Company considers an impairment as other than temporary if it is unlikely the Company will recover an investment’s amortized cost in a reasonable period of time. Factors considered by the Company include but are not limited to the impact of issuer specific events, industry specific events, current and expected future market and economic conditions, the nature of the investment and the severity and duration of the fair value deficiency.
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
An impairment loss of $4,713, comprised of $4,326 of common shares and $387 of Canadian corporate bonds, has been recognized in net income during 2008. No provisions were recorded in 2007.
A remaining gross unrealized loss of $14,757 on investments held as at December 31, 2008, is recorded, net of tax, in the amount of $9,887 as Accumulated Other Comprehensive Loss. The Company has concluded during its review, that these fair value deficiencies are considered temporary in nature.
Investment income
Investment income was derived from the following:
2008 2007
Interest income $11,596 $ 9,653
Dividend income 1,664 1,102
Net realized (losses) gains and impairments (1)
(4,833) 3,350
Foreign exchange gain (loss)(2)
2,706 (155)
Investment expenses (1,124) (996)
$10,009 $12,954
(1) Net realized (losses) gains and impairments include realized losses of $121 (2007 – gain of $3,350)
and impairments of $4,712 (2007 – NIL).
(2) The foreign exchange gain of $2,706 (2007 loss of $155) arises primarily from cash balances held
during the year, denominated in U.S. dollars, used to fund claims liabilities, denominated in U.S. dollars.
5 Unearned premiums 2008 2007
Gross Ceded Gross CededPersonal Lines: Automobile
- accident benefits $15,592 $ 821 $16,435 $ 892- liability 23,803 1,051 18,512 1,031- other 11,746 112 9,836 185
Total Personal Lines 51,141 1,984 44,783 2,108
Niche:Property
- commercial 5,743 666 5,341 576- personal 1,284 141 311 41
Liability 4,526 795 2,963 646Accident and sickness 6,941 94 14,939 220Other 1,519 32 853 11
Total Niche 20,013 1,728 $24,407 1,494$71,154 $3,712 $69,190 $3,602
63
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
6 Provision for unpaid claims
The determination of the provision for unpaid claims and adjustment expenses and the related reinsurers’ share requires the estimation of three major variables or quanta, being development of claims, reinsurance recoveries and the effects of discounting, to establish a best estimate of the value of the respective liability or asset.
The provision for unpaid claims and adjustment expenses is an estimate subject to variability and the variability could be material in the near term. The variability arises because all events affecting the ultimate settlement of claims have not taken place and may not take place for some time. Variability can be caused by receipt of additional claim information, changes in judicial interpretation of contracts, significant changes in the severity or frequency of claims for historical trends, the timing of claim payments, recoverability of reinsurance and future rates of investment return. The estimates are principally based on the Company’s historical experience. Methods of estimation have been used, which the Company believes produce reasonable results given current information.
All provisions are periodically reviewed and evaluated considering emerging claims experience and changing circumstances. The process of determining the provisions necessarily involves risks that actual results may differ, perhaps materially, from the best estimates made. The resulting changes in estimates of the ultimate liability are recorded as incurred claims in the current year.
The fair value of the provision for unpaid claims approximates carrying value determined in accordance with generally accepted actuarial methods in Canada, which discount estimated future cash flows and include a margin for adverse deviation.
The Company discounts its best estimate of claim provisions at a rate of interest of 2.45% for 2008 (2007 – 2.8%) for all lines of business. The Company determines the discount rate based on the expected return on its investment portfolio of assets with appropriate assumptions for interest rates relating to reinvestment of maturing investments.
The Company has recorded a $5,097 (2007 – $11,807) reduction to the net provision for unpaid claims relating to redundancies in prior year estimates.
To recognize the uncertainty in establishing these best estimates, to allow for possible deterioration in experience, and to provide greater comfort that the actuarial liabilities are adequate to pay future claims, the Company includes provisions for adverse deviations (PFADs) in some assumptions relating to claim development, reinsurance recoveries and future investment income. The PFADs selected are in the mid-range of those recommended by the Canadian Institute of Actuaries. The aggregate impact of the provision for adverse deviation is to increase the provision for unpaid claims on a gross basis by $20,102 as at December 31, 2008 (2007 – $17,487).
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
The following table shows the effects of discounting on unpaid claims and adjustment expenses.
Undiscounted
Effect of presentvalue PFADs APV
2008 Provision for unpaid claims and
adjustment expenses $179,426 $(14,273) $20,102 $185,255 Reinsurers’ share of unpaid claims 39,411 (1,423) 3,913 41,901
$140,015 $(12,850) $16,189 $143,354
2007 Provision for unpaid claims and
adjustment expenses $164,267 $(12,663) $17,487 $169,091 Reinsurers’ share of unpaid claims 47,115 (3,083) 4,429 48,461
$117,152 $ (9,580) $13,058 $120,630
The provision for unpaid claims on an APV gross and ceded basis by line of business is as follows:
APV basis 2008 2007
Gross Ceded Gross Ceded
Personal lines:
Accident benefits $ 72,008 $21,396 $ 64,794 $23,526
Liability 91,555 17,218 86,919 22,509
Other 4,336 656 3,607 663
Total Personal lines $167,899 $39,270 $155,320 $46,698
Niche:
Property
Commercial $ 3,273 $ 247 $ 4,371 $ 520
Personal 332 20 101 50
Liability 8,377 1,960 3,967 1,180
Accident and sickness 4,728 404 4,940 13
Other 646 – 392 –
Total Niche $ 17,356 $ 2,631 $ 13,771 $ 1,763
$185,255 $41,901 $169,091 $48,461
7 Underwriting policy and reinsurance ceded
In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events that cause unfavourable underwriting results by purchasing reinsurance to share all or part of the insurance risks originally accepted by the Company in
65
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
writing premiums. This reinsurance does not relieve the Company of its primary obligation to policyholders.
During 2008, the Company followed the policy of underwriting and reinsuring contracts of insurance, which limits the net exposure of the Company to a maximum amount on any one loss to $1,500 (2007 - $1,150). In addition, the Company obtained catastrophe reinsurance which limits the loss from a series of claims arising from a single occurrence to $2,000 (2007 - $1,150), to a maximum coverage of $18,000 (2007 - $13,850).
The Company places all its automobile reinsurance with Canadian registered reinsurers. There are non-registered reinsurers participating on the specialty property and casualty program business. The Company has access to trust funds that, in the Company’s judgment, are adequate to secure the liabilities that the Company has ceded to non-registered reinsurers.
Failure of reinsurers to honour their obligations could result in losses to the Company. Consequently, the Company continually evaluates the financial condition of its reinsurers and monitors concentrations of credit risk to minimize its exposure to significant losses. There have been no defaults and no provision made in the accounts for defaults based on management’s review of the creditworthiness of its reinsurers.
Reinsurance recoverables
The following table summarizes the balances outstanding from reinsurers as at December 31, 2008 by risk rating:
Credit rating
Grossreinsurancerecoverable
Less: Provisions and securities
held Net exposure
A $47,860 $ – $47,860
Not rated 613 2,133 –
$48,473 $2,133 $47,860
Included in gross reinsurance recoverable is reinsurers’ share of unearned premiums of $3,712 reinsurers’ share of provision for unpaid claims of $41,901 and receivables from reinsurers presented as due from insurance companies of $2,860. No balances due from reinsurers are considered past due as at December 31, 2008.
8 Risk management
As a provider of insurance products, effective risk management is fundamental to EGI’s ability to protect the interests of EGI’s customers and shareholders. EGI is exposed to risks of loss pertaining to insurance products. These include risks surrounding product and pricing, underwriting and claims, catastrophic exposure, and matching of assets and liabilities. EGI is also exposed to potential loss from various risks, including interest rate risk and equity market fluctuation risk, credit risk, liquidity risk, and to a lesser extent foreign exchange risk.
The Company has written principles for overall risk management, as well as written policies covering specific areas such as underwriting, reinsurance, foreign exchange risk, interest rate risk, credit risk, use of derivative financial instruments and non-derivative financial instruments and investment of excess liquidity.
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
Product and pricing
EGI prices its products taking into account numerous factors, including claims frequency and severity trends, product line expense ratios, special risk factors, the capital required to support the product line, and the investment income earned on that capital. EGI’s pricing process is designed to ensure an appropriate return on capital and long-term rate stability avoiding wide fluctuations in rates, unless necessary. These factors are reviewed and adjusted periodically to ensure they reflect the current environment.
Pricing for automobile insurance must be submitted to each provincial government regulator and, in certain provinces, pre-approved by the regulator. Regulatory decisions may impede automobile rate increases or other actions that EGI may wish to take. Also, during periods of intense competition for any product line, to gain market share, EGI’s competitors may price their products below the rates EGI considers acceptable. Although EGI may adjust its pricing up or down to maintain EGI’s competitive position, EGI strives to ensure its pricing will produce an appropriate return on invested capital. There is no assurance that EGI will not lose market share during periods of pricing competition.
Underwriting and claims
EGI is exposed to loss resulting from the underwriting of risks being insured and the exposure to financial loss resulting from greater than anticipated adjudication, settlement and claims costs.
EGI’s underwriting objectives are to develop business within EGI’s target markets on a prudent and diversified basis and to achieve profitable underwriting results. EGI underwrites automobile business after a review of the applicant’s driving record reports and claims experience. Specialty commercial and personal risks are selected by EGI, working with its external brokers, after consideration of various risk factors associated with these lines of business. Despite its best efforts, and consideration of all known risk factors, there can be no assurance that all risks associated with the insurance policies that it writes can be identified and assessed, and EGI may, therefore, experience increased adjudication, settlement and claims costs.
EGI estimates its claims reserves on a quarterly basis and this is supported by quarterly assessments by the independent consulting actuary. Every quarter, for each line of business, EGI compares actual and expected claims development. To the extent that actual results differ from expected development, assumptions are re-evaluated and new estimates are derived. Although EGI believes its overall provision levels to be adequate to satisfy its obligations under existing policies, actual losses may deviate, perhaps substantially, from the amounts reflected in EGI’s consolidated financial statements. To the extent provisions prove to be inadequate, EGI would have to re-evaluate such provisions and may incur a charge to earnings in the future.
Unpredictable catastrophic events
Catastrophes can be caused by various natural and unnatural events. Natural catastrophic events include hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires. Unnatural catastrophic events include hostilities, terrorist acts, riots, crashes and derailments. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to
67
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
small geographic areas; however, hurricanes, windstorms and earthquakes may produce significant damage in large, heavily populated areas.
Catastrophes can cause losses in a variety of business lines. Claims resulting from natural or unnatural catastrophic events could cause substantial volatility in EGI’s financial results and could materially reduce EGI’s profitability or harm EGI’s financial condition. The Company manages the impact of losses which may result from catastrophic events by purchasing excess of loss and catastrophe reinsurance to share all or part of the insurance risks originally accepted by the Company (note 7).
EGI’s ability to write new business also could be affected. EGI may experience an abrupt interruption of activities caused by unforeseeable and/or catastrophic events. EGI’s operations may be subject to losses resulting from such disruptions. Losses can relate to property, financial assets, trading positions and to key personnel. EGI has developed business continuity plans designed to allow the Company to continue operations in case of a catastrophic event; however, if these plans cannot be put into action or do not take such events into account, losses may further increase.
Financial asset and liability matching
The Company is exposed to:
• changes in the value of its fixed income securities and policy liabilities to the extent that market interest rates change;
• equity price fluctuations, which affect the fair values of equities held by the Company;
• the risk of losses to the extent that the sale of a security prior to its maturity is required to provide liquidity to satisfy policyholder and other cash outflows;
• the risk that future inflation of policyholder cash flows exceed returns on long- term investment securities; and
• foreign exchange risks with respect to investments, receivables and policy liabilities denominated in foreign currencies.
To mitigate these risks, the Company has policies to ensure that assets and liabilities are broadly matched in terms of their duration and currency. The Company's exposures are monitored on a regular basis and actions are taken to balance investment positions when approved risk tolerance limits are exceeded.
Risk management is carried out by the Investment Committee under policies approved by the Board of Directors.
Market risk
Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, equity market fluctuations, foreign exchange rates, and other relevant market rate or price changes. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying financial assets are traded. Below is a discussion of the Company’s primary market risk exposures and how these exposures are currently managed.
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
Interest rate risk
Fluctuations in interest rates have a direct impact on the fair valuation and future cash flows of the Company’s fixed income securities portfolio. Generally, the Company’s investment income will be reduced during sustained periods of lower interest rates as higher yielding fixed income securities mature or are sold and the proceeds are reinvested at lower rates. During periods of rising interest rates, the fair value of the Company’s existing fixed income securities will generally decrease and gains on fixed income securities will likely be reduced.
The sensitivity analysis for interest rate risk as set out in the table below illustrates the impact of changes in interest rates on OCI relating to the fixed income securities portfolio as at December 31, based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments.
As at December 31, 2008 As at December 31, 2007
Change in interest rates
Fair value of
fixed income
portfolio
Hypothetical
change on
fair value
Effect on
OCI
Fair value of
fixed income
portfolio
Hypothetical
change on fair
value
Effect on
OCI
200 basis point rise $202,324 (9%) $(14,162) $166,475 (11%) $(12,921)
100 basis point rise 212,438 (5%) (7,386) 175,763 (6%) (6,790)
No change 223,462 – – 186,052 – –
100 basis point decline 235,533 5% 8,087 197,536 6% 7,579
200 basis point decline 248,463 11% 16,751 210,482 13% 16,124
Liquidity risk
Liquidity risk is the risk that an entity will encounter difficulty in raising funds to meet cash flow requirements associated with financial instruments. The purpose of liquidity management is to ensure that there is sufficient cash to meet all financial commitments and obligations as they fall due. To manage cash flow requirements, the Company maintains a portion of invested assets in liquid securities.
The maturity profile of bonds as at December 31, 2008 is as follows:
Less than
1 year 1 – 3 years 3 – 5 years
Greater
than
5 years Total
Bonds $10,187 $46,959 $57,135 $109,181 $223,462
Percentage of total 4.6% 21.0% 25.6% 48.8% 100%
69
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
Future cash flows
The following table summarizes the expected timing of cash flows arising from insurance obligations, on an undiscounted basis (note 6), as at December 31, 2008:
Less than1 year 1 – 3 years 3 – 5 years
Greaterthan
5 years Total
Actuarial liabilities (undiscounted) $59,526 $63,161 $34,627 $22,112 $179,426 Less: Reinsurance recoverable 14,499 14,812 6,615 3,485 39,411
Net actuarial liabilities $45,027 $48,349 $28,012 $18,627 $140,015
All other financial liabilities with the exception of bank indebtedness (note 14) and lease commitments (note 15) are for a duration of one year or less.
Equity price risk
Fluctuations in the value of equity securities affect the level and timing of recognition of gains and losses on securities held, and causes changes in realized and unrealized gains and losses. General economic conditions, political conditions and many other factors can also adversely affect the stock and bond markets and, consequently, the value of the equity and fixed income securities held.
The Company has policies to limit and monitor its exposure to individual issuers and classes of issuers of equity securities.
The table below summarizes the potential impact of a 20% change in the value of the equity securities (common and preferred shares) on OCI for the year ended December 31, 2008. Certain shortcomings are inherent in the method of analysis presented, as the analysis is based on the assumptions that all equity holdings increased/decreased by 20% with all other variables held constant.
Change in equity holdings
Effect onOCI
20% rise $ 4,592
20% decline ($4,592)
Credit risk
The Company is exposed to credit risk principally through its investment securities and balances receivable from policyholders and reinsurers. The Company has policies to limit and monitor its exposure to individual issuers and classes of issuers of investment securities which do not carry the guarantee of a national or Canadian provincial government. EGI's credit exposure to any one individual policyholder is not material. The Company has policies which limit its exposure to individual reinsurers and regular review processes to assess the creditworthiness of reinsurers with whom it transacts business.
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
The Company’s maximum exposure to credit risk, without taking into account amounts held as collateral is $288,062, comprised of $223,462 of bonds $47,860 of gross reinsurance recoverables, $9,063 of amounts due from insurance companies and $7,677 in structured settlements.
The following table sets forth EGI’s fixed income securities portfolio by credit quality according to DBRS as at December 31.
Fixed income portfolio
As at December 31, 2008
As at December 31, 2007
Fair value Fair value Fair value Fair value AAA $107,830 48% $100,388 54%AA 60,713 27% 43,015 23%A 48,080 22% 37,631 20%BBB 6,765 3% 5,018 3%
CCC 74 – – –
Total $223,462 100% $186,052 100%
Foreign exchange risk
Foreign exchange risk is the possibility that changes in foreign exchange rates produce an unintended effect on earnings and equity when measured in domestic currency.
A portion of the Company’s premiums are written in US dollars and a portion of loss reserves are also in US dollars. In addition, premiums relating to the Emergency Travel Health line of business are remitted in Canadian dollars but a significant portion of the claims incurred for this line of business are in US dollars. A portion of the Company’s cash and investments are also held in US dollars.
In general, the Company attempts to manage foreign exchange risk on liabilities by investing in financial instruments denominated in the same currency as the financial liabilities which they back. The Company may, nevertheless, from time to time experience losses resulting from fluctuations in the value of the US dollar, which could adversely affect operating results.
The table below illustrates the expected impact on net income and OCI of a 10% change in the Canadian dollar (“CAD”) compared to the US dollar (“USD”) as at December 31, 2008. Computations of the prospective effects of hypothetical foreign exchange changes are based on numerous assumptions, including the maintenance of the existing level and composition of financial assets and financial liabilities, and should not be relied on as indicative of actual or future results.
Change in CAD / USD rate
Effect on Net Income Effect on OCI*
10% rise ($665) $100
10% decline 665 (108)
71
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
Capital management
Capital is comprised of the Company’s shareholders’ equity and bank indebtedness. As at December 31, 2008, the Company’s shareholders’ equity was $118,604 and bank indebtedness was $19,550. The Company’s objectives when managing capital are to maintain financial strength and protect its claims paying abilities, to maintain creditworthiness and to maximize returns to shareholders over the long term.
A common measure of capital adequacy in the property and casualty industry used by management is the ratio of premiums to surplus (or shareholders’ equity). A lower ratio implies a higher measure of capital adequacy. The Company’s ratio as at December 31, 2008 is 1.3:1. This level is well below the 2.5:1 ratio considered by management to be the maximum acceptable ratio.
The Company’s Canadian insurance subsidiary, Echelon, is required to maintain minimum capital levels as required by the Office of the Superintendent of Financial Institutions. As at December 31, 2008 and 2007, the Company exceeded the minimum regulatory capital requirement. Legislation applicable to insurance companies imposes certain restrictions on the Company’s ability to pay dividends.
9 Fixed assets 2008 2007
CostAccumulated amortization Net Cost
Accumulated amortization Net
Furniture and equipment $1,577 $ 663 $ 914
$533 $ 459 $ 74
Computer hardware 293 211 82 253 153 100
Computer software 3,029 1,653 1,376 2,318 1,242 1,076
$4,899 $2,527 $2,372$3,10
4 $1,854 $1,250
10 Share capital
2008 2007
Authorized
Unlimited common shares
Unlimited special shares issuable in Series
Issued
11,676,282 common shares(2007 - 9,682,152 common shares)
$67,056 $46,040
In July 2008, the Company issued rights to eligible holders of outstanding common shares of
the Company of record on July 4, 2008, to subscribe for and purchase from the Company an
aggregate of 1,943,630 common shares, at a price of $10.75 per share.
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
Completion of the rights offering on July 31, 2008, resulted in issuance of 1,943,630 common
shares for $20,773 in net proceeds. The Company intends to use the proceeds for general
corporate purposes.
During 2008, 50,500 (2007 – 43,000) common shares were issued pursuant to the exercise of employee stock options, with an issue cost of $4.82 (2007 – $4.82) per share.
11 Employee stock option plan
The Company sponsors a stock option plan. The stock option plan provides for the issuance of shares of the Company’s common stock not exceeding 10% of the total issued and outstanding shares (on a non-diluted basis) and shares reserved for issuance under employee stock option plans, options for services and employee stock purchase plans. The Board of Directors determines the terms and conditions of the awards under the stock option plan as well as any award allocations.
For the year ended December 31, 2008, the Company recorded a compensation expense of $186 (2007 – $123), with an offsetting credit to contributed surplus. During 2008, 50,500 (2007 – 43,000) stock options were exercised. All stock options granted are for a term of five years with varying vesting periods.
The following is a continuity schedule of stock options outstanding as at December 31, 2008 and 2007:
Number of shares
Weighted average
exercise price per share
2008 2007 2008 2007
Outstanding, beginning of year 825,500 681,750 $ 7.79 $ 6.07
Granted during year 127,750 186,750 9.11 13.26
Exercised during year (50,500) (43,000) 4.23 4.23
Outstanding, end of year 902,750 825,500 $ 8.18 $ 7.79
73
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
EGI Financial Holdings Annual Report 2008
As at December 31, 2008, the outstanding stock options consist of the following:
Stock Option price per share Number
Remaining
contractual life
Number of options
exercisable
$4.23 330,500 0.8 years 236,500
$5.09 45,000 1.3 years 27,000
$10.61 90,500 1.8 years –
$10.31 6,750 2.3 years –
$9.26 70,500 2.8 years –
$9.65 45,000 3.0 years 18,000
$11.03 3,000 3.3 years –
$11.68 20,000 3.6 years –
$12.80 26,750 3.6 years 4,000
$11.68 10,000 3.6 years 6,000
$12.34 45,000 3.7 years –
$14.26 92,000 3.8 years –
$13.89 6,750 4.0 years –
$13.20 3,000 4.3 years –
$11.80 6,750 4.4 years –
$10.65 6,000 4.6 years –
$10.47 6,750 4.7 years –
$8.03 81,750 4.8 years –
$6.35 6,750 5.0 years –
The fair values of the stock options issued in 2008 were determined using the Black-Scholes option pricing model with the following assumptions: (i) risk-free rate of 2.0%; (ii) life expectancy of four years; (iii) estimated volatility of 30%; and (iv) dividend yield of 1.7%. The grant-date fair value of total options granted is estimated at $1,085. The weighted average grant-date fair value of stock options granted to date is $1.04.
12 Related party transactions
The Co-operators Group Limited and Co-operators General Insurance Company (collectively Co-operators), significant shareholders of the Company, provide services to the Company, including but not limited to product distribution and investment management services. Direct written premiums derived from Co-operators’ agents was $12,564 (2007 – $15,180), commissions paid were $1,493 (2007 – $1,744) and investment management fees were $200 (2007 – $175).
The Company holds deposits of $1,421 (2007 – $2,781) under the terms of a 2001 100% Quota Share reinsurance treaty with Co-operators General Insurance Company, with income resulting from the investment of these deposits for their account. Reinsurers’ share of unpaid claims includes a recoverable of $1,714 (2007 – $2,058) from Co-operators General Insurance Company. The payable to insurance companies balance includes amounts due to Co-operators General Insurance Company of $1,426 (2007 – $2,790).
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands, except per share amounts)
13 Income taxes
The income tax expense (recovery) is as follows:
2008 2007
Current $3,453 $7,839
Future (476) 32
$2,977 $7,871
The provision for income taxes reflects an effective rate, which differs from the corporate tax rate as follows:
2008 2007
Combined basic Canadian federal and provincial
income tax rate 33.5% 36%
Income tax expense at statutory rates $2,998 $8,257
Permanent differences (16) (226)
Future income tax rate changes 212 (2)
Other (217) (158)
$2,977 $7,871
Future income taxes are comprised of the following:
2008 2007
Losses carried forward $ 273 $ 26
Provision for unpaid claims 2,896 2,774
Investments (326) (520)
Deferred costs 152 329
Fixed assets 177 65
$3,172 $2,674
75
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands except per share amounts)
EGI Financial Holdings Annual Report 2008
Income taxes included in OCI
The amounts included in the consolidated statements of changes in shareholders’ equity and
comprehensive (loss) income for the years ended December 31 are shown net of the following
tax benefit:
Tax impact on: 2008 2007
Change in unrealized gains and losses $(5,215) $ (299)Reclassification to net income of (gains) and losses 1,729 (1,242)
Total income tax benefit included in OCI $(3,486) $(1,541)
14 Bank indebtedness
On October 11, 2007, the Company entered into a non-revolving term loan facility with a major
Canadian bank in the amount of $19,550. The facility has a term of three years, bearing an
interest rate of 6.20%. During the term of the loan, monthly payments will include interest only
and on maturity a balloon payment of $19,550 will be made to settle the principal amount.
15 Lease commitments
The Company is committed under lease agreements for office premises and computer equipment with minimum lease payments of $9,245 as follows:
2009 $1,090
2010 954
2011 926
2012 904
2013 936
2014 and thereafter 4,435
$9,245
16 Structured settlements
In the normal course of claims adjudication, the Company may settle certain long-term losses through the purchase of annuities (structured settlements) from life insurance companies. The fair value of these annuity contracts amounts to $7,677 (2007 – $4,105) using a discount rate of 3.45% (2007 – 5.00%). It is the policy of the Company to purchase annuities from life insurers with proven financial stability. The net risk to the Company is the credit risk related to the life insurance companies and this risk is reduced to the extent of coverage provided by Assuris, the life insurance compensation insurance plan. The Company has determined that no credit risk provision is required.
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands except per share amounts)
17 Contingencies
From time to time, in connection with its insurance operations, the Company is named as a defendant in actions for damages and costs allegedly sustained by the plaintiffs. While it is not possible to estimate the outcome, such actions have generally been resolved with minimal damage or expense in excess of amounts provided as policy liabilities. The Company does not believe that it will incur any significant additional loss or expense in connection with such actions.
18 Rate regulations
The Company writes business subject to rate regulation, including non-standard automobile and motorcycle insurance, which comprises approximately 65% of net premiums written. The Company’s automobile insurance premiums can be impacted by mandatory rate rollbacks and mandatory rate assessments as legislated by provincial law and by regulation in certain provinces. This could result in lower future premium rates or reductions to premium rates charged by the Company in prior years. In addition, the Company is required, under certain provincial legislation, to participate in risk sharing pools, which may impact positively or negatively on underwriting results. Certain benefit payments are also subject to provincial government regulation, including automobile accident benefits.
The Company is not aware of any proposed or pending rate rollbacks related to prior years.
19 Earnings per share
2008 2007
Basic earnings per share:
Net income available to shareholders $ 5,979 $15,065
Average number of common shares (in thousands) 10,532 9,655
Basic earnings per share $ 0.57 $ 1.56
Diluted earnings per share:
Average number of common shares (in thousands) 10,532 9,655Average number of common shares obligation under
employee stock option plan (in thousands) 814 761
Average number of diluted common shares (in thousands) 11,346 10,416
Diluted earnings per share $ 0.53 $ 1.45
20 Segmented information
The Company operates through three segments. The Personal Lines and Niche Products divisions operate in Canada while the International division assumes premiums from U.S. resident companies that specialize in the non-standard automobile market. Through its Personal Lines division, the Company is engaged primarily in the underwriting of high premium, non-standard automobile insurance. Through its Niche Products division, the Company designs and underwrites specialized non-auto insurance programs, such as higher premium property,
77
EGI FINANCIAL HOLDINGS INC. Notes to Consolidated Financial Statements (continued)
(in $ thousands except per share amounts)
EGI Financial Holdings Annual Report 2008
primary and excess liability, legal expense, accident and health insurance and warranty coverage.
The effect of reinsurance is reflected in the revenue and results of the three divisions. The investment activities consist of managing the investment portfolio for the Company as a whole. Investment income is shown net of investment expenses. The corporate and other activities include holding company expenses not attributable to a division. Interest expense represents interest on bank indebtedness.
Year ended December 31
2008 2007
Revenue
Earned premiums and other revenue
Property and casualty insurance
Canada - Personal Lines $ 98,665 $ 87,700
- Niche Products 46,009 23,900
144,674 111,600
International (United States) 12,581 8,006
157,255 119,606
Interest and dividends, net of investment expense 12,136 9,759
Realized investment (losses) gains (4,833) 3,350
Foreign exchange gains (losses) 2,706 (155)
Total revenue $167,264 $132,560
Income (loss) before income taxes
Property and casualty insurance
Canada - Personal Lines $ 7,058 $ 10,664
- Niche Products (3,183) 297
3,875 10,961
International (United States) (2,404) (17)
Corporate and other (1,308) (703)
Underwriting income 163 10,241
Interest and dividends, net of investment expense 12,136 9,759
Realized investment (losses) gains (4,833) 3,350
Foreign exchange gains (losses) 2,706 (155)
Interest expense (1,216) (259)
Total income before income taxes $ 8,956 $ 22,936
21 Comparative figures
Certain comparative figures have been reclassified to conform with the current consolidated financial statement presentation.