Great-West Lifeco Inc.

Thank you for standing by. This is the conference operator. Welcome to the Great West LifeCo conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there'll be an opportunity for analysts to ask questions. To join the question queue, you may press star then 1 on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star then 0. I would now like to turn the conference over to Mr. Paul Mann, President and CEO of Great West Life Co. Please go ahead.

Thank you, Ariel. Good morning and welcome to Great West Life Co.' 's first quarter 2023 conference call. Joining me on today's call is Gary McNicholas, Executive Vice President and Chief Financial Officer. Together, we will deliver today's formal presentation. Also joining us on the call and available to answer your questions are David Harney, President and COO of Europe, Arshil Jamal, President and Group Head, Strategy, Investment, Reinsurance, and Corporate Development. Jeff McCowan, President and COO, Canada. Ed Murphy, President and CEO of Empower. And Bob Reynolds, President and CEO of Putnam Investments. Today we'll share two presentations. The first is an IFRS 17 comparative period analysis. We will then share our quarterly results presentation. Following this, we will take questions on both presentations. Before we start, I'll draw your attention to our cautionary notes regarding forward-looking information and non-GAAP financial measures and ratios on slide two. These cautionary notes also appear on slide two of our quarterly results presentation and apply to the information we will discuss later in this call. Please turn to slide four. We've adopted and successfully transitioned to IFRS 17, marking the culmination of a significant multi-year enterprise-wide initiative. we are reporting Q1 2023 financial performance under the new standard for the first time. This first presentation provides insight into the impact of IFRS 17 by illustrating quarterly comparative results for the year ended December 31, 2022. Recognizing this represents a significant change from IFRS 4 reporting, we believe the new regime offers greater visibility into the strengths, underlying economics and diversification of LIFCO's portfolio. As we shared with you pre-implementation, these new standards do not have a material impact on our operating company's business strategies or the underlying economics of their businesses. Moreover, our overall Great West Lifeco strategies are not impacted by the transition to IFRS 17. We will continue to focus on building and sustaining market leadership positions across our diversified businesses. There are three primary changes you will observe as we unpack our comparative financial performance for 2022. First, under IFRS 17, there are some changes to the timing of earnings recognition on medium and longer-term insurance products, generally smoothing out certain items which were recorded as upfront gains under IFRS 4. However, when we combine this smoothing with the pickup from amortizing the opening contractual service margin, or CSM, The transition to IFRS 17 only resulted in a 2% reduction in the level of base earnings during the 2022 comparative period. This reduction has been more than offset by a 4% positive impact from an updated definition of base earnings going forward. So to sum up, we expect little change to the future direct trajectory of base earnings. Gary will cover this in more detail in his upcoming comments. The second impact relates to the delinking of asset and liability discount rates, which creates greater volatility in net earnings, but with base earnings much less impacted. Gary will also cover this in greater detail. Thirdly, from a balance sheet perspective, shareholders' equity and book value have decreased by 12% and 14% respectively. This is in line with previous estimates and is largely driven by the creation of the new CSM. Our financial strength is unaffected by the transition to IFRS 17 and our LICAT ratio increased by 10 points. As Gary will describe, we have purposefully allowed for additional net earnings volatility around interest rates as a trade-off to gain greater LICAT stability. Given these impacts and with our business strategies unchanged, we are confirming our medium-term financial objectives for base EPS growth and our target dividend payout ratio ratio are unchanged, but are increasing our ROE objectives. I will cover these points in a few moments. Please turn to slide five. As we advance our business strategy, we're enhancing our reporting and disclosures to provide greater clarity and transparency into how the company is creating value for shareholders. The transition to IFRS 17 and IFRS 9 naturally allow for this change. This slide illustrates our three value creation drivers, workplace solutions, wealth and asset management, and insurance and risk solutions. It also outlines the IFRS 17 impact for the businesses associated with each driver. Looking at Lifeco's portfolio, over 70% of our base earnings saw limited or no impact from the transition to the IFRS 17, primarily the businesses that represent stronger growth areas for Lifeco. This includes workplace solutions, which represent our group life and health and our group retirement businesses, like the Empowered Defined Contribution business, and wealth and asset management, which represent asset management and individual wealth businesses, like Empower Personal Wealth and our segregated fund business in Canada. As illustrated on the page, insurance and risk solutions is more impacted by the transition to IFRS 17, with individual insurance and longevity businesses most impacted. In contrast, the structured and P&C reinsurance businesses saw limited impact. Please turn to slide six. This slide highlights our medium-term financial objectives. As noted earlier, we're maintaining our medium-term objective of 8% to 10% base EPS growth given the modest impact of IR4S17 on base earnings. Our base ROE objective is changing as a result of the creation of the CSM and resulting reduction in shareholder equity. The medium-term base ROE objective increases to a range of 16% to 17%, an increase of 2% from the current objective. Base ROE will continue to be supported by strong and stable returns from a diversified portfolio of businesses and our increased focus on capital light business growth. Our target dividend payout ratio of 45% to 55% of base earnings remains unchanged given the limited impact on the level of base earnings and with the highly cash-generative nature of our businesses. I'll now turn the call over to Gary to get into more detail. Gary? Thank you, Paul.

Please turn to slide eight. This slide depicts how the insurance contract liability changes from IFRS 4 to 17 and highlights the two main differences in regimes. The best estimate liability under IFRS 4 essentially becomes the present value of future cash flows under IFRS 17. However, the liability cash flows are valued use a market-consistent discount rate rather than being tied directly to the backing assets. This is referred to as delinking of the assets and liabilities under IFRS 17, which is one of the main changes of the move, and it impacts both base and net earnings. With the delinking, provisions for financial risks, such as interest rate mismatch, are no longer required. The risk adjustment, on the other hand, is very similar to the current insurance PFADs, but the risk adjustment allows explicitly for diversification and therefore will be lower than PFADs, especially for companies like ours with a well-diversified portfolio of business. The other main change under IFRS 17 is the creation of the Contractual Service Margin, or CSM. The CSM is a new liability that reflects deferred profits released into earnings over time. The CSM has implications to both the balance sheet and the timing of earnings recognition. Turning to slide nine. On transition to IFRS 17 and 9, we saw a reduction of 12% in shareholders' equity and 14% for book value per share. This is a result of the net reduction of retained earnings, driven primarily by establishing a CSM on the enforced business. And as communicated previously, our base ROE objective has increased by 2%. Our financial leverage ratio calculation reflects the inclusion of the CSM related to our non-participating, non-segregated fund insurance business on an after-tax basis. We saw a modest improvement in this metric on this basis. While our approach aligns to how we anticipate certain rating agencies will view this, others have been less clear on exactly how they'll adjust to the new regime. The agencies have all indicated in general terms they don't see the accounting changes as having a big impact on leverage nor affecting ratings. For LICAP, we saw an improvement in our ratio largely due to OSFI including the CSM as available capital, which offset the retained earnings reduction. and also due to removing the 1.05 scaler on required capital. Notwithstanding heightened market-related earnings volatility in 2022 under the new regime, we saw a more stable LICAT ratio due to asset liability management and accounting choices, which we'll discuss later. Please turn to slide 10. As noted earlier, there are two main changes with the move to IFRS 17, the introduction of the CSM and the de-linking of assets and liabilities. The CSM mechanism effectively defers the earnings impact of certain business experience or activities, such as new business gains, certain trading activity and insurance experience, and non-financial assumption changes. These impacts will be recognized into earnings over time rather than immediately. Overall, given the mix of business and relative sizes of new business volumes and in-force CSM, the implication of this is only a modest change in base earnings for our IFRS 17 business. However, we've also noticed there can be differences in how different types of insurance experience are reflected in earnings. For example, mortality experience, gains and loss in life insurance tend to be recognized into earnings immediately, whereas longevity experience on paid annuities would tend to be deferred via the CSM and recognized in earnings over the life of the remaining contracts. This leads to an earnings recognition timing issue. We saw this directly in our Q1 results. we experience a very similar size to almost completely offsetting results from mortality and longevity, with mortality losses coming through the P&L and longevity gains coming through as a CSM adjustment. Since the CSM is included as available capital within LICAT ratio, the impact on regulatory capital is more neutral, which is aligned with the overall economics. The delinking of assets and liabilities leads to greater potential net earnings volatility, We reviewed our asset liability management accounting policy choices to align with the underlying economics of the business and to have a greater focus on supporting a more stable LICAT ratio with the trade-off against additional net earnings volatility. Please turn to slide 11 as we expand on this. As noted at our IFRS 17 information session last June, we intend to use the yields on our own assets, net of an allowance for credit risk, to set the IFRS 17 liability discount rate. We chose this option because it reflects the underlying economics, aligns with our general matching approach to asset liability management, and it reduces net earnings volatility. When setting our IFRS 17 liability discount rate, there are two variations. For certain portfolios, our own fixed income assets are very representative of the duration and liquidity characteristics of liabilities without adjustments. For these portfolios, trading impact Trading activity will impact the portfolio yield, which drives the discount rate used in the IFRS 17 liabilities and results in an immediate earnings impact. For portfolios with very long-dated liabilities, for example, Canadian Universal Life Products, it can be difficult to source assets with similar duration liquidity characteristics. For these portfolios, we'll use the yields on our own assets plus an illiquidity adjustment to set the IFRS 17 liability discount rate. As we trade our fixed income assets, we will adjust the additional illiquidity to compensate, and that leads to the earnings impact being recognized over time rather than immediately. Within the 2022 comparative period, the impact of trading activity reflected immediately within earnings reduced by about half compared to the prior regime. The underlying economics of the trading activity is the same, and the remaining half of this impact will emerge into earnings over time. Turning to slide 12, this shows a visual depiction of the balance sheet, our ALM choices and accounting choices, and the resulting outcomes. With the move to IFRS 17, we had a strong focus on ensuring the underlying economics of the business were appropriately reflected, maintaining our financial strength via a stable LICAT ratio and book value while accepting modest net earnings sensitivity. Best estimate liabilities are largely backed by fixed income with a good duration match. and electing these on fair value through profit and loss aligns the fair value impacts on both assets and liabilities, creating minimal earnings and capital volatility. We have viewed the risk adjustment CSM differently. Both count as regulatory capital. The CSM is not interest rate sensitive since the interest is locked in when established, and this works well with LICAT solvency requirements that are also set using a stable interest rate, The risk adjustment calculation is interest rate sensitive, although one could argue that it may not have the same interest rate sensitivity as best estimate liabilities. Therefore, we've generally backed these amounts with assets that are not directly interest sensitive, such as non-fixed income assets or fixed income assets measured at amortized cost. This allows us to maximize risk adjusted returns while limiting LICAT ratio volatility due to interest rate movements. Within our surplus segment, we've chosen to largely use shorter-term fixed income assets to ensure a strong liquidity position to support our dividend-payout ratio and provide flexibility. These assets are measured at fair value through OCI where possible to limit earnings volatility. The result of these ALM and accounting choices is a more stable balance sheet exposure to interest rates, as highlighted by limited sensitivities to a 50 basis point change in interest rates. Turning to slide 13, 2022 was certainly a good year to road test these choices in a volatile macro environment. In Canada, we saw back-to-back quarters of greater than 50 basis points of long-term rate increases in 2022. We also saw material increases in interest rates in other geographies where we operate, particularly within the UK, where risk-free rates increased by more than 3% over the first three quarters of 2022. In the first part of the year, we saw higher net earnings under IFRS 17. The increase in interest rates reduced the value of our liabilities, which for the most part was offset by reduced asset values. However, for the portion backed by non-fixed income or amortized cost assets, the asset fair values did not reduce to the same extent as the liabilities, leading to a positive earnings impact. This helped offset formulaic LICAT ratio declines as rates increased. And also in 2022, we experienced adverse non-fixed income experience, largely driven by poor Canadian public equity performance in Q2 and poor UK real estate fair value performance in Q4, and this flowed directly into earnings. But despite all this market volatility, as shown across the bottom of the slide, our LICAT ratio, as shown on a pro forma IFRS 17 basis, was very stable. Turning to slide 14. This shows the comparison of base earnings on IFRS 4 and 17 on a quarterly basis for 2022. This is a much more stable pattern than net earnings on the prior slide. The relative impact of switching regimes varies by quarter, largely due to the type of business activity and experience results in each quarter. The comparisons by quarter are very much impacted by the specifics. For example, which portfolios had trading activity, the extent of new business gains, and which type and direction of insurance experience gains and losses, mortality, longevity, and pulse order behavior. Overall, these impacts balanced out across the year, resulting in the modest impact we had originally anticipated. Turn to slide 15. As noted in our previous disclosures, we were expecting a modest reduction in base earnings due to the transition to IFRS 17. The results of our 2022 comparative came in aligned with that expectation. with a decrease in base earnings of just under 2% before the definition changes. The key drivers of the change reflect the two impacts I spoke to earlier, the dynamics of the CSM and the delinking of assets and liabilities. And for the CSM-related impacts, we saw a slight improvement to base earnings as the benefit of CSM amortization outweighed the reduction due to deferring new business profit. The delinking of assets and liabilities led to a decrease in the immediate earnings benefit of trading activity Even though CSM is not involved, these benefits are deferred and the higher spread emerges as earned over time. And as noted on the far right, we also updated our base earnings definition to exclude the amortization of acquisition-related finite life intangible assets. This improved base earnings by 129 million or 4%. Turning to slide 16, the impact on base earnings across regions also showed limited to modest impacts with the transition. We have included a visual to give a sense of proportion of business impacted by IFRS 17 within each region. For Canada, roughly 70% of the business had limited to no impacts. And within the rest, there were largely offsetting impacts as CSM enforced runoff versus new business deferral and experience impacts were a positive versus IFRS 4. This offset the impact of deferring the benefits of trading activity. For the U.S., in the most part, it has fairly limited impacts due to IFRS 17 and IFRS 9. The main impact was an improvement in base earnings due to the updated definition that removes amortization of acquisition-related intangibles, which have increased in recent years given the significant M&A activity. And in Europe, roughly 60% of the business has limited or no impacts, and the decrease in base earnings was driven by the deferral of real estate lease extension benefits or yield enhancement on the real estate, with 2022 having had a higher volume of these than historically. The CSM impacts largely balanced out. And finally, capital risk solutions saw an improvement to their results as the transition CSM runoff was greater than the deferral of new business gains. And new business growth within reinsurance was largely in their structured and P&C products, which are more short-term business and no CSM, resulting in very similar earnings between IFRS 4 and 17. So turning to slide 17, in conclusion, we view the transition to IFRS 17 as very successful, and we look forward to describing our results going forward under the new regime. I'm sure there will be a settling in period with all the new disclosures and metrics, and we look forward to working with you as we all get comfortable and conversant with the new regime.