Great-West Lifeco Inc. (GWO) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the Great-West Lifeco IFRS 17 Information Session. I would now like to turn the conference over to Mr. Paul Mahon, President and CEO of Great-West Lifeco. Please go ahead.

Thank you, Ariel. Good morning, and welcome to Great-West Lifeco's IFRS 17 Information Session. Joining me on today's call are Garry MacNicholas, Executive Vice President and Chief Financial Officer; Dervla Tomlin, Executive Vice President and Chief Actuary; and Charles Henaire , Executive Vice President and Deputy Chief Financial Officer. Garry, Dervla and I will deliver today's formal presentation and Charles will join us for the question-and-answer portion of the call. 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 2. These apply to today's discussion and presentation materials. Please turn to Slide 4. IFRS 17 represents a major change to the financial reporting regime for insurance contracts in many jurisdictions around the globe. This has been a long time coming. Insurance sector participants around the globe have been working on this for many years and we're now just over 6 months away from transition. Today, we'd like to review at a high level how we see the change to IFRS 17 impacting Great-West Lifeco from both the financial and business strategy perspective. Through our joint release and recent company-specific sessions held by our peers, a lot of general education has been provided regarding this accounting regime change. We're not planning to repeat this general education today. Rather, we'll focus on the specific impacts of the transition of IFRS 17 for Great-West Lifeco. If there's one key message to take away from today's session, it is this: We do not see IFRS 17 having a material impact on either Great-West Lifeco's business strategies or its financial performance. IFRS 17 is an accounting regime change. A strong company well positioned for value creation before the change is still a strong company well positioned for value creation after the change. There will certainly be impacts to the balance sheet and to the presentation and emergence of earnings. I'll summarize these in a couple of key points, and then Garry and Dervla will provide more detail from a Great-West Lifeco impact perspective. Our business 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. We will continue to operate with discipline and a strong risk culture, focused on building lasting value for our customers. And we will continue to prioritize organic, consolidation and business extensions growth across our portfolio of companies. Our focus remains on creating value for all stakeholders in the years ahead. Looking at Lifeco's portfolio, it is important to note that businesses representing over 70% of our pro forma base earnings will see little to no impact from the change to IFRS 17. This includes our wealth and group retirement businesses like Empower, our short-term renewal businesses like Group Life and Health in Canada and Europe and our pass-through and fee-based insurance businesses like participating insurance and segregated funds. Many of these businesses represent growth areas for Great-West Lifeco. From the balance sheet perspective, we expect shareholders' equity and, therefore, book value to decrease by 10% to 15% with the creation of the new Contractual Service Margin liability or CSM. The opening CSM represents deferred profits on in-force business which will come back into earnings over time. With 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 are recorded as upfront gains today. However, when we combine this smoothing with the pickup from amortizing the opening CSM, we only expect a modest low single-digit net reduction in the level of pro forma base earnings and little change to the future trajectory of base earnings. Given this and with our business strategies unchanged, we're confirming our medium-term financial objectives for base EPS growth and our target dividend payout ratio. We are, however, increasing our base ROE objective by 2% to the range of 16% to 17% to reflect the reduction in shareholders' equity. Finally, as noted at the outset, this is an accounting regime change. We do not see it impacting in any way our excellent financial strength nor our ability to pursue value-creating opportunities in the future. And with that, I'll turn the call over to Garry and then Dervla to review some of the key implications of IFRS 17 in greater detail. Garry?

Thank you, Paul. Please turn to Slide 6. This slide outlines the impact of IFRS 17 changes from a type of business and product perspective across our portfolio. The business mix percentages we are showing are based on pro forma earnings which takes account the expected 2022 IFRS 4 earnings mix and composition as at the start of 2022 adjusted to include MassMutual and Prudential acquisitions on a fully synergized basis, which is more representative of our post IFRS 17 expected business mix. I should also note that the numbers in this presentation do not take account of current market conditions and the changes in volatility experienced thus far in 2022. We will provide updates on those impacts as part of our normal Q2 reporting. Looking at the table, we can see that wealth, asset management and short-term and fee-based insurance businesses, which comprise approximately 70% of our pro forma business mix, will see little to no impact on base earnings under IFRS 17. This includes many of our largest and fastest-growing businesses, Empower, Canada Group, Germany and much of Irish Life. It also includes our asset management businesses in the U.S. and in Europe. Medium duration individual insurance and longevity businesses will see a moderate impact to earnings emergence. Given these liabilities are typically quite well matched from an ALM perspective and generally mature blocks of business, the main impact will be the deferral of new business gains through the CSM. Some of these gains have been quite lumpy in the past, for example, on large bulk annuity or reinsurance longevity transactions. So we expect to see a smoother base earnings emergence for these businesses over time. We expect to see greater impacts on long-duration individual insurance products, which represent about 5% of our pro forma earnings mix. These products are more difficult to fully match with fixed income assets and so can be more significantly impacted by IFRS 17. In addition to deferring any new business gains through the CSM, there will also be a smoother recognition of the yield enhancement gains we have historically experienced in these businesses as and when we source attractive longer-duration assets. In addition, outside of base earnings, the impact of market movements on the non-fixed income assets in these portfolios will be more immediately recognized under IFRS 17 than occurs today under IFRS 4. Please turn to Slide 7. This slide summarizes those same IFRS 17 impacts, but from a segment perspective. In Canada, Group Wealth is not impacted, and the impacts on Group Life and Health and individual segregated fund businesses are limited. Long-duration nonparticipating individual insurance in Canada will be more impacted under IFRS 17. But as noted on the prior slide, our overall exposure to this type of business is fairly modest. In the U.S. Putnam and Empower, including Personal Capital, have immaterial exposure to IFRS 17. Given the intense focus on successfully integrating our recent acquisitions, we were certainly thankful that we do not have to add significant IFRS 17 on work on top. In Europe, there is limited impact to our market-leading U.K. group and Irish Group Life and Health businesses and, similarly, our Irish and German pension businesses. We expect our mature book of U.K. annuities to see a modest impact, primarily due to the deferral of new business gains through the CSM, as noted earlier. In Capital and Risk Solutions, there's a limited impact on structured life and P&C reinsurance and a moderate impact on longevity swaps, mostly new business gain deferrals similar to the annuities. We also expect to see limited impact on our mature block of the U.S. traditional life reinsurance business, which primarily covers term products. So when we look across the portfolio, other than Canada, with the long-duration individual insurance business, we don't see a material impact on a segment-by-segment basis. Please turn to Slide 8. This slide highlights our medium-term financial objectives. As Paul noted, we are maintaining our medium-term objective of an 8% to 10% base EPS growth given the modest base earnings impacts from IFRS 17. IFRS 17 changes the timing of earnings, not the quantum. There is a small reduction in base earnings in the early periods as new business and yield enhancement gains are deferred into the future. However, given the modest size of this impact, it does not really alter the growth trajectory of Great-West Lifeco's expected base earnings going forward. Our base ROE objective is changing as a result of the creation of CSM and the resulting reduction in shareholders' equity. The medium-term base ROE objective increases to a new 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 increasing 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 growth trajectory. The business remains highly cash generative under the new accounting standard. And with that, I'll now turn the call over to Dervla to take us through the next few slides.

Great. Thank you, Garry. Starting on Slide 10, I'll give a quick recap on how the insurance contract liability changes from IFRS 4 to IFRS 17. The best estimate liability under IFRS 4 essentially becomes the present value of future cash flows under IFRS 17, but there are some important differences. Rather than being directly tied to the backing assets, liability cash flows are valued using a market consistent discount rate based on instruments with similar characteristics to the insurance contract. For example, similar duration and liquidity. The financial guarantees embedded in segregated funds and participating insurance are valued on a market-consistent basis, which adds some conservatism compared to today's valuation. Asset-related provisions within our IFRS 4 liability, for example the provision for interest rate risk on the investment, will no longer be required under IFRS 17. The risk adjustment is the provision for insurance risk within the IFRS 17 liability. It's very similar to the current insurance PfADs, but the risk adjustment allows explicitly for diversification and therefore will be lower than the existing PfADs for Great-West Lifeco given our well-diversified portfolio of business. One of the main changes under IFRS 17 is the creation of the Contractual Service Margin or CSM. And the CSM is a new liability that reflects deferred profits. For future new business, the CSM will be created instead of recognizing a new business gain immediately in earnings, as happens today under IFRS 4. And the CSM is released into earnings over time as insurance contracts are fulfilled. On the transition date, which is the first of January 2022, we revalued the in-force liabilities and determined the risk adjustment. Because IFRS 17 applied retrospectively, we'll also establish a CSM on our in-force business, which represents the remaining unamortized deferred profits as if the in-force business had been measured under IFRS 17 from inception. Please turn to Slide 11. Because some of the existing provisions within our IFRS 4 liability will no longer be required under IFRS 17, the insurance liability excluding the CSM will reduce on transition. This reduction in the liability will lead to an increase in shareholders' equity. At the same time, we'll establish the Contractual Service Margin for our in-force insurance business, which will reduce shareholders' equity. We estimate that the net impact of these changes will be about a 10% to 15% reduction in book value. But it's important to note this is an accounting presentation change. The economics of the business and the underlying financial strength of the company have not changed. From a capital perspective, ASB has communicated that the CSM and risk adjustment will count as regulatory available capital and that will update the LICAT guideline with an objective to minimize industry-wide capital impacts on transition. We expect ASB to publish the revised LICAT guideline shortly. And based on ASB's guidelines, its stated objective to minimize industry-wide capital impacts on transition and current market conditions, we expect a positive impact on the Canada Life LICAT ratio on the transition to IFRS 17. We're also engaging with rating agencies and don't anticipate any adverse impact to leverage our ratings. Therefore, we don't expect any change in our deployable capital. So to summarize, while the creation of the CSM will lead to a transfer from shareholders' equity, there is no impact on the financial strength of our business or on our deployable capital. Please turn to Slide 12 to look at base earnings. As Garry outlined, we anticipate a modest transitional impact to the level of base earnings. IFRS 17 earnings are expected to be slightly lower than IFRS 4 earnings, a low single-digit difference. And we've estimated this on a pro forma basis and assuming our 2022 IFRS earnings mix and composition, as expected at the start of the year, adjusted for the fully synergized impacts of the recently acquired Prudential and MassMutual businesses. The main drivers of the change in the level of base earnings will be the deferral of new business gains, a smoothing of the recognition of yield enhancement and a lower regular release of provisions, reflecting the back to the risk adjustment is lower than the combined assets and insurance PfADs under IFRS 4. But these changes will be largely offset by the amortization of the in-force CSM set up on transition. We've used a pro forma basis to give an indication of the impact on the level of base earnings given the nature of our business and typical drivers of earnings. The actual impact in the comparative year 2022 will depend very much on the specific composition of the 2022 earnings. For example, the level of new business gains in yield enhancements, which can fluctuate significantly from period to period. Looking ahead post transition, we don't expect any material change to the trajectory of our base earnings. As Garry outlined, our growth priorities remain focused on wealth management and other capital-light businesses, largely unaffected by IFRS 17. And our insurance businesses are expected to continue to make a steady contribution. The amortization of the opening CSM will support the stability of base earnings. But given our growth priorities and the size of the opening CSM, CSM growth is not expected to be a key driver for overall earnings growth. Please turn to Slide 13. We thought it would be useful to give you some insight into our approach to valuing assets and liabilities and how we will set our discount rates. We intend to measure assets-backed in insurance liabilities at fair value through profit and loss. That means that the impact of market movements on liabilities and on the assets backing those liabilities are both recognized in profit and loss. So just like today under IFRS 4, the impact of market movements will be included in net earnings, but we will continue to exclude these impacts from base earnings. One exception to this measurement basis would be for assets backed in the CSM. These would be measured at amortized cost or fair value through OCI, which aligns with the fact that the CSM liability is not intrasensitive because it's measured at locked-in rates. Turning to discount rates. For liability portfolios that can be matched with assets with similar duration and liquidity characteristics, for example our payout annuity portfolios, we use 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 aligns well with our approach to asset liability management where we generally seek to match cash flows and duration. Using our own assets to set the liability discount rate will limit the volatility in net earnings due to movements in interest rates and spreads because the value of our liabilities will move in line with the value of our assets. There will still be limited volatility where we achieve not to fully match liability to fixed income assets. For example, if we would use real estate assets to back a portion of our liabilities. We continue to trade fixed income assets as part of our normal investment management process. As long as the revised asset portfolio remains representative of the characteristics of the liability, we'll use the yield on the revised portfolio to get the liability discount rate. So if you trade into assets with higher yields, there will be immediate positive earnings impact and, conversely, an immediate earnings hit if we trade into lower yielding assets. For portfolios with very long-dated liabilities, for example Canadian Universal Life products, it can be difficult to source assets with similar duration and liquidity characteristics. For these portfolios, we use yields on our own assets plus a further illiquidity adjustment to set the IFRS 17 liability discount rate. Most of our yield enhancement in recent years has been on these portfolios. Under IFRS 17, if we trade into higher-yielding, less liquid assets, we'll update our illiquidity adjustment to be minimal impact to the overall liability discount rate and therefore a minimal immediate earnings impact. Instead, the benefit of the higher asset yield will flow into earnings over time. Using our own assets as the foundation to set the liability discount rate will reduce the volatility in net earnings due to movements in interest rates and spreads. However, there will be a modest level of net earnings volatility because it is difficult to exactly match the duration of these liabilities and we do invest in some non-fixed income assets to back this type of business. Now I'll hand back to Paul for closing remarks.

Thank you, Dervla. Please turn to Slide 14. Today, Great-West Lifeco is a strong, well-diversified financial services company, well positioned for growth and value creation and the move to IFRS 17 does not change that. We're the same company before and after the change. We've outlined the relatively modest financial impacts of IFRS 17 on Great-West Lifeco. And other than adjusting for the increase in ROE as a direct result of transition, we have confirmed our key medium-term financial objectives are not changing. Our business 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 portfolio of businesses. And we will continue to prioritize opportunities for long-term value creation through organic growth, consolidation plays and business extensions. As a company, we are well positioned for this change, and we're looking forward to working with industry participants in the quarters ahead as we transition to IFRS 17. That concludes our formal remarks. And Ariel, would you please open the line for questions.

[Operator Instructions] Our first question comes from Meny Grauman of Scotiabank.

First question on the CSM growth outlook, if there's any specific targets for total CSM and then also for new business CSM.

Thanks, Meny. It's Paul. I'm going to turn that one over to Garry. Garry?

Yes. Thanks, Paul. No, Meny, we're not actually setting specific growth targets for the CSM overall. I think as Dervla noted, we have a large opening CSM and a lot of our growth focus is on our other businesses. So it's -- we don't see the new business CSM growth is a key driver for us. Now obviously, things will evolve over time. But at this early stage, no, we're not disclosing our or setting or disclosing targets on new business or in for CSM growth. We do expect it to grow, but we haven't set targets for it.

Okay. That was my follow-up question on that. And then in terms of the LICAT, just if you could talk to the expected volatility from this change to IFRS 17. Does LICAT volatility likely to decrease as a result of this change?

Yes. Meny, I think we would anticipate a decrease, but I'll let Garry cover a bit more that in a bit more color. Garry?

I've got Dervla here with me. So I think maybe, Dervla.

Yes. I think obviously it will depend. We haven't obviously got the final LICAT guideline. So obviously, our remarks obviously have to be caveated because of that. But at this stage, based on our conditions where they are currently, we would expect similar or slightly less volatility in the IFRS 17 LICAT than the kind of IFRS 4 LICAT.

And that's being driven by change to rate sensitivity of the LICAT? Or how do you explain that if it's...

Exactly. Yes. Yes..

Our next question comes from Tom MacKinnon of BMO Capital.

Just with respect to your discussions with rating agencies. I think you had indicated that there's no change in terms of their ratings or opinions. Do you know how they're going to be treating the CSM? Are they treating it similar to OSFI's? There naturally would be a change in leverage ratios. But are they -- how are they treating CSM given the discussions you're having with them?

Thanks, Tom. Garry, why don't you take that question?

Sure. Thanks. So Tom, at this point, the rating agencies haven't confirmed exactly what they're going to do. They've made comments about making the appropriate adjustments. So I think how they go about adjusting for the CSM, certainly, in the conversations have been -- they recognized the need to make adjustments. And I think you might find different rating agencies take slightly different approaches in terms of their actual calculations. But -- so we don't have an exact one. But they've certainly indicated that they -- there's a need to adjust for the CSM. They don't see a change to ratings arising. I think they've all been fairly clear on that. So I think they themselves are working through the details of how they're going to make the adjustments. But we're not expecting any adverse outcomes from that based on our conversations.

Okay. And as a quick follow-up, I think you had mentioned that -- [indiscernible] Dervla mentioned that there's no change in deployable capital. So how much is this deployable capital? And how much does it increase each year?

Garry, why don't you take that?

Sure. Yes. So Tom, this is a reference a lot of people would look at. Obviously, for us, we'll have any cash resources in the U.S. or at the Lifeco holding company. That's part of our overall deployable. Some people would include the leverage capacity, which is a bit constrained at the moment given our recent acquisitions. But the item I think we're more specifically referring to there is a lot of people look and say, okay, how much LICAT -- how much capital do you have over and above your LICAT target of? In our case, 110% to 120%. And so often, people would say, okay, we've got -- if your LICAT ratio is in the 130s, people estimate how much is deployable over the top end of your range. And since the CSM counts and the risk adjustment count as part of that the LICAT capital, then the transition over to IFRS 17 isn't going to change the amount in and of itself because that's -- it's all part of LICAT. So we don't see a major change there. I mean, there's a little bit of a pickup in LICAT than we flagged. And that will obviously depend -- the exact amount depends on the conditions at the time. But there's a little pickup there. But that's what we meant by the no deployable. It's not affecting the U.S., not affecting Lifeco cash. And because CSM is counting as LICAT, it's not really affecting that either.

Okay. And is there any disclosure on how much that increases like in terms of the dollar amount year-over-year?

In terms of our growth rates, I mean that, we don't have forward projections on that. But it's taking, -- obviously, a lot of our earnings are cash generative. And then we'll have our outgoes . We don't have a disclosed here as the net amount that we're adding to deployable each year, but something we should think about.

Our next question comes from Gabriel Dechaine of National Bank Financial.

Are you going to be -- my questions are on Slide 13. Are you going to be disclosing the discount rates used for your assets and liabilities and then also the breakdown of liabilities between the ones that get the portfolio rate and then the ones that get the portfolio rate plus the illiquidity premium?

Thanks, Gabriel. Thanks, Gabe. I'll turn that one over to Dervla and Garry.

Yes, we will be -- look, in our financial statements then, we will be disclosing how we set the discount rates for the major portfolios. So yes, we will be describing the methodology and giving some of the key numerics as well, will be part of the disclosure.

Will we actually see the numbers?

Yes. I don't think we'll be disclosing kind of pages and pages of different discount rates, but we'll be setting -- we will be setting out the methodology and [indiscernible]. Yes.

And just to -- I was listening but -- and also distracted. But the -- again, Slide 13, trading activity will be reflected in the liability discount rate in the period. And then the impact of trading activity emerges over time in that second category That one, I believe, is -- the impact of trading activity, that's in referral to -- reference to the yield enhancement gains, that's where you would have got yield enhancement gains historically. And now these instead of being present valued all at once, they'll be spread out over time. If that's correct, incorrect, let me know. But as far as trading activity will be reflected in the liability discount rate, can you clarify what that means and how that's going to look?

Yes. So take the long duration -- the -- sorry, the portfolio which was a very long duration liabilities that you described it correctly what was previously under IFRS 4 reported as yield enhancement will emerge over time through the higher asset yield. So that's the second type of business on Page 13. If you look at the other business where we can our existing asset portfolio is very representative of the characteristics of our liability, so for example, for our annuity portfolios, we're going to use the yield on our assets to test the liability discount rate. So there'll be a direct connection between the asset yield and the liability discount rate so that they will move in tandem. So that's what we're making on that portfolio. But just maybe to -- I just like to set some context. I think it was mentioned that in recent years most of our yield enhancement has actually been on those very long-duration portfolio, the sort of -- the example of the Canadian Universal Life portfolio so -- where we'll see the equivalent of yield enhancement being recognized into earnings over time.

Got it. So the closely matched stuff, if you will, is going to move around like the current call methodology. So they offset the changes in interest rates. And then the longer duration portfolio, the yield enhancement gains, since these -- they would be spread out over like 20, 30 years kind of thing because of the nature of that portfolio?

Yes. They'd be over the...

Yes [indiscernible] the asset.

That is your [indiscernible]. And Dervla, that will be about 3/4 [indiscernible]

That will be 3/4 of recent gains, yes.

3/4 of what, sorry?

So of our recent IFRS 4 yield enhancement gains, about 3/4 of those gains would have been on those very long duration.

Our next question comes from Doug Young of Desjardin Capital Markets.

Just to maybe put a final point on Slide 13 and yield enhancement. Are you -- in the base earnings, are you assuming a set level for the yield enhancement or investment gains in the base earnings calculation? Is anything changing there? Or is this just the spread? Are you just going to realize it as it comes through and this is just the spread between the asset yield and the liability discount rate that is going to be pushed through over time? Just trying to get a sense of how to think about this.

Dervla, do you want to carry on with that?

Yes. So if we take those kind of long duration portfolios, exactly as you described, any sort of excess on the asset return relative to our liability discount rates will come into earnings over time as we earn that asset yield and that will come into base earnings. For the kind of very well-matched portfolio, we'll have a direct link between the liability discount rate and the asset return. And we'll update the discount rate as our asset returns changes. So that -- so effectively an immediate capitalization benefit as they move in tandem and that will also come into base earnings. But as we just mentioned earlier, most of what was recognized as yield enhancement under the [indiscernible] basis was really arising on those long-duration liabilities. So they will [indiscernible] definitely spread into earnings over time. But our investment earning our -- and those types of investment earnings will come into base earnings.

So you're not making an explicit assumption in base earnings like $100 million or 10 million. Just as this comes through and the net of the impact of that, it's going to be lower than it was before, but this is just providing context. I get that. So on 13, can you provide a split of the liability between the 2 buckets? Do you have that handy that you could give?

I wouldn't -- we don't have the exact liabilities. I think we were trying to indicate just in the rough size of the -- like our business mix by earnings is a way to look at it. But don't have the liabilities of the -- that will be part of the updated disclosure, of course. But the earnings mix, I mean, those long-duration portfolio is about 5% and the medium-term ones are more like 25%. That's in terms of earnings power.

Yes. No, that's fair. And then back on capital on LICAT. Can you describe why it's positively impacted for you? Is this just the removing of scaler? Is there something else that's positively getting -- you're getting a positive impact on LICAT? And can you size that positive impact?

Garry, I'll let you carry that.

Sure. Certainly, the removal of the scaler is certainly one of the -- is a positive factor. I mean there's a number of changes, obviously, between the 2. But the removal of the scaler would be a contributing positive factor. We did look at it, estimated it at the -- what the opening balance sheet date would be, which is back at year-end, by January 1, where we had a look there, it was a couple of points. And I think we -- it's not quite as sensitive to interest rate rises as the current one, at least at the rates that were in existence to the start of the year. So that gap has probably widened a couple of points since then. We hope to be able to give more of an update at the Q2 meeting when we have the actual second quarter balance sheet and perhaps by then we'll have the final -- sort of I think we'd hope to have the final ASB guidelines then. So we should be able to give more of an update. But there was a couple of points there and it's probably widened a couple of points since then.

Yes. But Garry, to be -- sorry, I just wanted to say, Doug, to be clear, it will be the prevailing economic conditions transition that will define what that will be right now. So to some degree, some speculation, and we should put it in that context.

That's fair. Just it would be good to get a little bit more detail. I know you guys have to wait for the final factors come out, guideline comes out, but it would be interesting to get a little more moving pieces. And then just last, I just want to clarify something. Is the -- in the CSM, are you including unallocated expenses in the CSM? Are you not including unallocated expenses there?

Dervla, do you want to take that one?

Yes. Yes, so when we're calculating the liability value, we -- under IFRS 17, you look at what are called directly attributable expenses only. But I should point out, that's the vast majority of our expenses and really what your kind of -- the nonattributable expenses kind of relate to corporate overhead and branding, et cetera. So they're not a material amount of our overall expenses. And then to the extent, obviously, that those nonattributable expenses haven't been included in the liability valuation, but then by definition it leads to a higher CSM. So in that sense, yes, they are included in the CSM.

[Operator Instructions] Our next question comes from Paul Holden of CIBC.

First question is going back to financial leverage and your credit rating. Clear that there's no impact. Just wondering how we should be viewing financial leverage on a pro forma basis. Clearly, it's going to be higher. Or maybe you can adjust for the yield you'll adjust the way you report financial leverage based on the CSM. Or maybe you just simply have a higher target number. Wondering if you can help us think through that.

Garry, do you want to provide some color there?

Sure. Yes. I would -- I mean, it's -- we'll need to be calculating both numbers. I think there'll be a raw calculation. And then there'll be -- whether we'll do the adjustments or give people all the information on the CSM so they can make their own adjustments, that's -- but I think all the information, there's a lot of disclosure on the IFRS 17 financials, so all the information will be there to do the calculations. And as I mentioned in an earlier question, I think each of the rating agencies will have their way of factoring CSM and doing adjusted leverage calculations.

Yes. Maybe another way to ask the question is how will -- what will be the true constraint on your financial leverage from an internal perspective? How are you going to look at the new constraint on your leverage?

Yes. I think we'll be very mindful of the threshold for our current ratings as established by the rating agencies. It's just the way we are today. So we'd look at those constraints relative to our ratings and, obviously, our overall capital management. But it's really, I think we'd be looking at the rating agency constraints through that. I'd say we don't expect it to change how we go -- how we conduct our business out, how we'd "firepower" for future acquisitions. So it's -- I think it's just got to settle out in the [ JAC ] calculations. But we're just -- whether it's having a higher raw calculation with higher thresholds or whether it's having adjustments and similar thresholds to today, I think that remains to be seen. And it may vary by rating agency.

Got it. Got it. Understood. Next question is with respect to this approach for discounting the liabilities because I think it's an important point. I guess the question I want to ask is, what does it imply for book value volatility, and maybe not just for the discounting, but IFRS 17 holistically? Should we expect book value volatility from quarter-to-quarter to increase? Or maybe with the discounting approach you've taken, it's not a material impact?

Garry or Dervla, do you want to provide some color on our perspective?

Yes, sure. certainly, the way we've taken the -- I think Dervla described this, the approach to a lot of the portfolios where we -- the more of the medium-term ones, where we can match quite well by using our own assets as the starting discount rate, that removes a lot of that volatility. So that will really take away the book value noise because it's -- the market impacts allows to be offsetting between the 2. And again, largely fixed income. When we look at the longer duration ones, there is -- I think I mentioned it [ mine ] , there will be a little more market volatility. Because unlike today where there's some smoothing of the non-fixed income assets that's available, that smoothing wouldn't exist. So to the extent we have those non-fixed income assets in the portfolio, there is the potential for more volatility there than exists today. Again, given the size of that business relative to our overall book, we're not -- don't expect it to be material, but there is a greater source there. And then obviously, we have to finalize our -- just our overall ALM as we approach IFRS 17. But I think that separating asset and liability values for the non-fixed income in those long duration is probably the increased source.

That's helpful. And then, Garry, your answer included a comment on finalizing ALM. Can you give us any more color there in terms of potential changes in asset duration or asset allocation?

Yes. I would say -- I'd just start with, philosophically, like our approach to matching our assets and liabilities with the fixed income as we have for a number of years, that overall philosophy isn't changing. What we are looking at though -- a couple of things we're looking at, is the fact that the -- obviously, the risk adjustment is smaller than our existing PfADs, so in terms of rebalancing the funds for that. And also, as we look at the sensitivity of LICAT to interest rate moves, and it's really the risk adjustment component of LICAT. So we're just really being thoughtful on how we look at the risk adjustment matching to make sure that we're balancing both an earnings book value perspective and the LICAP perspective on that. So that's really where our focus is. But our philosophy is very similar to today.

Got it. Okay. And one last question, it's kind of a bigger picture question. Paul, you kept emphasizing that IFRS 17 doesn't change business strategy and totally appreciate that. Just wondering if you were looking at potential acquisition opportunities and there might be something that could be of interest, but would be, say, fit into a bucket that's more impacted by IFRS 17. Like does that influence -- would that influence your decision making at all in terms of capital allocation? Just trying to figure out if it's completely other drivers that are taking into play your capital-light, fee-based strategy or maybe IFRS 17 at the end of the day is part of your thinking behind that.

Well, good question. And I would say that IFRS 17, to some extent, has influenced our view to strategy going forward. But having said that, I'm taking up a level and say that our primary view is trying to build and sustain leadership positions in markets, maintaining a degree of diversification across the portfolio and really establishing positions of strength where we really think we can sustain and have resilience in the business. So I would not say that we would shy away from an acquisition that had exposure to products and services that were more IFRS 17 sensitive. But I would say that if you thought broadly about our growth strategies currently, I mean we have been building this wealth business in the U.S., leveraging Empower. We're looking at similar extensions of our group business in Canada. So at the end of the day, if you kind of go back to where we think value will be created at the [ cold face ]with the customer, we really want to make sure we're focused there. And to the extent that an acquisition had some products that were more impacted by IFRS 17, we wouldn't shy away from it, but we would go back to those strategic principles of value creation with the customer.

Our next question comes from Darko Mihelic of RBC Capital Markets.

My first question is just related to your European operations. I'm familiar with Solvency II and even the Solvency II reform. Where I'm a little less familiar is places like Ireland, Isle of Man, Germany and so on. And so I'm just wondering, I just want to confirm with you all that the change over to IFRS 17 has really no impact on your local capital requirements and your businesses there.

You go ahead, Dervla.

Yes, I'm going to say that it's correct. So all of our European businesses are subject to Solvency II. So they -- they're unaffected by -- from a regulatory balance sheet perspective from IFRS 17.

And is there considered to be sort of any impact in any of those jurisdictions from like competitive behavior? Or is it just not even remotely possible that any competitor would alter or change the way they do business based on IFRS 17?

Go ahead, Dervla.

No, I can't -- we keep on being in agreement, Paul. I can't imagine a change. A lot of the focus, obviously, for European insurers has been -- is very much on their Solvency II position. And I think that will continue to be the case.

And I think it -- Darko, I'd just add to that. It doesn't change our view of those businesses either. It's -- obviously, there's -- it's an accounting impact, it doesn't change the overall fundamentals of any business. So yes, I don't think this really features a lot in -- as we think about Europe.

Okay. Great. And then just lastly, going back to Slide 13. It's almost like a neat trick where you somehow married [ quant ] to IFRS 17. Up until now, I haven't heard of any companies suggesting that their actual underlying portfolio will be used as a discount rate. So I'm just wondering, does this -- by doing it this way, does this sort of handcuff you in a way with your portfolios, right? I mean because now what it means is there's no departure. I mean, if you're sort of linking the 2, you can't really alter your investment strategy because -- just very curious that you would link the discount rate to the assets which I thought specifically IFRS 17 was sort of angling us to not do. So if you do it, does it handcuff you in any way with the investment portfolio and whether or not you, in the future, you decide to make changes, does it disrupt things? Because now suddenly, the discount rate and your liabilities is -- you have to sort of look at the actual characteristics of the liabilities rather than the assets that you have. Is there any constraint by doing -- by sort of suggesting you're going to do it this way, I guess, is my question?

Thanks. A very good question and I think Garry can provide some color on that. Garry?

Sure. Thanks, Paul. So Darko, I think in short the answer is no, it doesn't constrain us in that sense. So what we're doing here is we're using our own portfolio of assets to be a reference portfolio. In other words, it's got -- our portfolio has characteristics that are very similar to liabilities, whether it's the liquidity, whether it's durations and so on. But for example, and I'm just -- this is an entirely made up example, but we could decide down the road at some point to say we'd like to take 30% of that portfolio and invest it in non-fixed income assets. So the remaining 70% -- and we just do a pro rata. The remaining 70% would still be a very good reference portfolio for the whole liability set because it would still -- it would be smaller but it would mimic the duration and all the characteristics. So you could use it as a -- as a reference portfolio to set the discount rate even if 30% -- I've just made up 30%, it could be 10%, could be 40%, even if a percentage of your portfolio is invested in something completely different. So you're not constrained to it has -- the portfolios have to be exactly the same size. I think that's the main point. Right now, we do use primarily fixed income, so it's -- that's why it's a minimum volatility. But it doesn't constrain you going forward. I think that was your question.

Exactly. I just want -- in other words, like if it's a really good reference portfolio, why do you -- how can you do a yield enhancement? I mean that's -- it's a weird concept. And I just say this is the first time I've seen an insurer suggests that they've actually used their underlying portfolio as the reference for the liability. So it's -- I'm just trying to think in my mind if there's any sort of outcome from that, that would surprise us later on. But you've answered that well.

Our next question is a follow-up from Tom MacKinnon of BMO Capital.

So just as a follow-up on the top part of that Slide 13. I mean the way I look at it is this is largely using fixed income assets that if you use a reference portfolio that's kind of similar to your assets, I think what you're really doing here is you're taking a liability discount rate plus a liquidity premium that in effect is probably pretty close when you look at it on a forward curve basis to the underlying characteristics of the asset portfolio. So essentially there, if you don't have any kind of trading activity, you really end up having limited volatility in earnings as a result of that approach. Is that a way to conceptualize that?

Tom, yes, I think you've captured that well. Dervla, anything else you'd add?

Yes. No, agree, Tom. Yes, that's exactly the case, yes.

Okay. And it's really -- so if someone's portfolio for any insurance company is kind of a shorter duration, they don't have any NFI in it, then essentially by using a rate that kind of reflects a reference portfolio plus this liquidity adjustment or illiquidity adjustment, I think we go back and forth between whether it's a liquidity or illiquidity adjustment, if that's the case in terms of their portfolio, we would probably see limited earnings volatility. It's only if you enter NFI into the equation that you end up getting more of this volatility. Is that -- is that another way of -- am I correct in that assessment?

Yes, tom, just -- I think I'll just add. Just for the -- this is the top half, these are the ones we can closely match. If your own assets, like let's say you have a portfolio of fixed income that really mirrors the characteristics of the liabilities and taking out credit, because that's obviously a characteristic of the assets. But if you take out credit from that, then those -- that really mimics liability. So it's the actual asset. So what takes out the volatility is when interest rates move or spreads move just in general in the market, the fair values move, the discount rate will automatically adjust on the liabilities to go with the assets. So it's -- they'll move in tandem, very similar to [ comm ]. So you don't have to play with all the adjustments. You could just use your own asset provided they're a really good match. Does that help?

Yes, that's good. And it's really if you end up having longer duration with NFI, that's you -- you lose that ability to prioritize as you so call it, right?

Correct. Yes.

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Mahon for any closing remarks.

Thank you, Ariel. And I'd like to thank all participants on the call today for your questions and for your interest. To summarize, the impact of IFRS 17 do not change our business strategy for Great-West Lifeco. As we've outlined, the financial impacts are modest and we are well positioned for a transition. And we do look forward to working with industry participants in the quarters ahead as we make this transition. And we look forward to reconnecting with many of you on our second quarter earnings call in August. Have a good summer. Take care.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.