Bank of Montreal 2010 Annual Report Download - page 72

MANAGEMENT’S DISCUSSION AND ANALYSIS
MD&A
Additional information concerning BMO’s involvement with variable
interest entities is included on pages 64 to 66 as well as in Note 9 on
page 128 of the financial statements.
Pension and Other Employee Future Benefits
BMO’s pension and other employee future benefits expense is calculated
by our independent actuaries using assumptions determined by
management. If actual experience differs from the assumptions used,
pension and other employee future benefits expense could increase or
decrease in future years. The expected rate of return on plan assets is a
management estimate that significantly affects the calculation of pen-
sion expense. Our expected rate of return on plan assets is determined
using the plan’s target asset allocation and estimated rates of return for
each asset class. Estimated rates of return are based on expected returns
from fixed-income securities, which take into consideration bond yields.
An equity risk premium is then applied to estimate equity returns.
Expected returns from other asset classes are established to reflect the
risks of these asset classes relative to fixed-income and equity assets.
The impact of changes in expected rates of return on plan assets is not
significant for our other employee future benefits expense since only
small amounts of assets are held in these plans.
Pension and other employee future benefits expense and obligations
are also sensitive to changes in discount rates. We determine discount
rates at each year end for our Canadian and U.S. plans using high-quality
corporate bonds with terms matching the plans’ specific cash flows.
Additional information regarding our accounting for pension
and other employee future benefits, including a sensitivity analysis
for key assumptions, is included in Note 23 on page 149 of the
financial statements.
Other Than Temporary Impairment
We have investments in securities issued or guaranteed by Canadian
or U.S. governments, corporate debt and equity securities, mortgage-
backed securities and collateralized mortgage obligations, which are
classified as available-for-sale securities. We review available-for-sale
and other securities at each quarter-end reporting period to identify
and evaluate investments that show indications of possible impairment.
An investment is considered impaired if an unrealized loss on the security
represents impairment that is considered to be other than temporary.
In making this assessment, we consider such factors as the type of
investment, the length of time and extent to which the fair value has
been below cost, the financial condition and near-term prospects of the
issuer, and our intent and ability to hold the investment long enough
to allow for any anticipated recovery. The decision to record a write-
down, its amount and the period in which it is recorded could change
if management’s assessment of those factors were different. We do not
record impairment write-downs on debt securities when impairment
is due to changes in market interest rates, since we expect to realize the
full value of these investments by holding them until maturity or when
they recover in value.
At the end of 2010, there were total unrealized losses of $25 million
on securities for which cost exceeded fair value and an impairment
write-down had not been recorded. Of this amount, $10 million related
to securities for which cost had exceeded fair value for 12 months or
more. These unrealized losses resulted from increases in market interest
rates and not from deterioration in the creditworthiness of the issuer.
Additional information regarding our accounting for available-for-
sale securities and other securities and the determination of fair value
is included in Note 3 on page 116 of the financial statements.
Income Taxes
The provision for income taxes is calculated based on the expected tax
treatment of transactions recorded in our Consolidated Statements of
Income or Changes in Shareholders’ Equity. In determining the provision
for income taxes, we interpret tax legislation in a variety of jurisdictions
and make assumptions about the expected timing of the reversal of
future tax assets and liabilities. If our interpretations differ from those of
tax authorities or if the timing of reversals is not as anticipated, our pro-
vision for income taxes could increase or decrease in future periods. The
amount of any such increase or decrease cannot be reasonably estimated.
Additional information regarding our accounting for income taxes
is included in Note 24 on page 155 of the financial statements.
Goodwill and Intangible Assets
Goodwill is assessed for impairment at least annually. This assessment
includes a comparison of the carrying value and the fair value of each
group of businesses to ensure that the fair value of the group is greater
than its carrying value. If the carrying value exceeds the fair value of
the group, a more detailed goodwill impairment assessment would
have to be undertaken. In determining fair value, we employ internal
valuation models such as discounted cash flow models consistent with
those used when we acquire businesses. These models are dependent
on assumptions related to revenue growth, discount rates, synergies
achieved on acquisitions and the availability of comparable acquisition
data. Changes in each of these assumptions will affect the determination
of fair value for each of the business units in a different manner.
Management must exercise judgment and make assumptions in deter-
mining fair value, and differences in judgments and assumptions could
affect the determination of fair value and any resulting impairment
write-down. At October 31, 2010, the estimated fair value of each of our
groups of businesses was greater than its carrying value.
Intangible assets are amortized to income on either a straight-line
or an accelerated basis over a period not exceeding 15 years, depending
on the nature of the asset. There are no intangible assets with indefinite
lives. We test intangible assets for impairment when circumstances
indicate the carrying value may not be recoverable. No such impairment
was identified for the years ended October 31, 2010, 2009 and 2008.
Additional information regarding the composition of goodwill
and intangible assets is included in Note 13 on page 138 of the finan-
cial statements.
Insurance-related Liabilities
Insurance claims and policy benefit liabilities represent current claims
and estimates for future insurance policy benefits. Liabilities for life
insurance contracts are determined using the Canadian Asset Liability
Method, which incorporates best-estimate assumptions for mortality,
morbidity, policy lapses, surrenders, future investment yields, policy
dividends, administration costs and margins for adverse deviation. These
assumptions are reviewed at least annually and updated to reflect actual
experience and market conditions. The most significant impact on the
liability results from a change in the assumption on future investment
yields. Future investment yields may be sensitive to variations in
reinvestment interest rates and impact the valuation of policy benefit
liabilities accordingly. If the assumed yield were to increase by one per-
centage point, net income would increase by approximately $77 million.
A reduction of one percentage point would decrease net income by
approximately $71 million.
Contingent Liabilities
BMO and its subsidiaries are involved in various legal actions in the
ordinary course of business.
Contingent litigation loss provisions are recorded when it becomes
likely that BMO will incur a loss and the amount can be reasonably
estimated. BMO’s management and internal and external experts are
involved in assessing any such likelihood and estimating any amounts
involved. The actual costs of resolving these claims may be substantially
higher or lower than the amounts provided. Additional information
regarding contingent liabilities can be found in Note 28 on page 159
of the financial statements.
70 BMO Financial Group 193rd Annual Report 2010