The Company has categorized its financial instruments based on the priority of the inputs to the valuation technique, into a three-level hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.
In determining the fair value of the Company’s derivative financial instruments, including swaps and options, the Company considers counterparty credit risk, as well as its own credit risk. In order to mitigate credit risk exposure, the Company transacts with counterparties that have a similar rating as the Company, prices its derivative liabilities based on its own credit rating, and generally holds collateral support agreements to limit its net derivative exposure with each counterparty.
At December 31, 2011, $263.0 million of structured securities classified as ABS, RMBS and CMBS, were classified as Level 3, representing 71.5% of the Company’s total Level 3 fixed maturity securities and 15.3% of the total structured securities at December 31, 2011.
The $4.1 million increase in interest expense related to assets allocated to the Wealth Management segment during the twelve-month period ended December 31, 2011, relative to the same period in 2010.
The decision to stop selling variable annuity and individual life products in the U.S. will not impact existing customers and their policies. The Company will continue to provide quality service to its policyholders, while focusing on the profitability, capital efficiency and risk management of its in-force business. The Company will continue to earn revenue and to provide policyholder benefits on its in-force business.
All inter-company transactions and balances between the Company and its subsidiaries have been eliminated in consolidation.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The most significant estimates are those used in determining the fair value of financial instruments, goodwill, deferred policy acquisition costs (“DAC”) including sales inducement asset (“SIA”), value of business acquired (“VOBA”), value of customer renewals acquired (“VOCRA”), liabilities for future contract and policyholder benefits, unearned revenue reserves, accruals, other-than-temporary impairments of investments, allowance for loan loss, valuation allowance on deferred tax assets and provision for income taxes. Actual results could differ from those estimates.
Real estate investments are held for the production of income or are held for sale. Real estate investments held for the production of income are carried at depreciated cost. Depreciation of buildings and improvements is calculated using the straight-line method over the estimated useful life of the asset. Real estate investments held for sale are primarily acquired through foreclosure of mortgage loans for which the carrying amount is established as the fair value less cost to sell at the foreclosure date. Real estate investments held- for-sale are measured at the lower of their carrying amount or fair value less costs to sell. Real estate investments are diversified by property type and geographic area throughout the United States.
The Company manages assets related to certain funds-withheld reinsurance agreements. These assets are primarily comprised of fixed maturity securities, mortgage loans, policy loans, equity securities, derivative instruments, related accrued income and cash and cash equivalents and are accounted for consistent with the policies described above. Investment income on assets within funds-withheld reinsurance portfolios is included as a component of net investment income in the Company’s consolidated statements of operations.
In April 2010, the FASB issued ASU 2010-15, “Financial Services-Insurance (Topic 944): How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments-a consensus of the FASB Emerging Issues Task Force,” to provide guidance regarding accounting for investment funds determined to be VIEs. Under this guidance, an insurance entity would not be required to consolidate a voting-interest investment fund when it holds the majority of the voting interests of the fund through its separate accounts. In addition, an insurance entity would not consider the interests held through separate accounts for the benefit of policyholders in the insurer’s evaluation of its controlling interest in a VIE, unless the separate account contract holder is a related party. The guidance is effective, on a retrospective basis, for fiscal years and interim periods within those fiscal years, beginning after December 15, 2010. The Company adopted ASU 2010-15 on January 1, 2011 and the adoption did not have a significant impact on the Company’s consolidated financial statements.
VOBA of $7.6 million is subject to amortization based upon expected premium income over the period from acquisition to the first customer renewal, which is generally not more than two years. VOBA was fully amortized as of December 31, 2009. VOCRA of $16.2 million is subject to amortization based upon expected premium income over the projected life of the in-force business acquired, which is 20 years. The Company recorded amortization for VOBA and VOCRA for the years ended December 31 as follows:
The amortized cost and fair value of fixed maturity securities held at December 31, 2011 were as follows:
“Impaired List”- This list includes securities that the Company has the intent to sell or more likely than not will be required to sell. In addition, it includes those securities that management has concluded that the Company’s amortized cost will not be recovered due to expected delays or shortfalls in contractually specified cash flows. For these investments, an OTTI charge is recorded or the security is sold and a realized loss is recorded as a charge to income. Credit OTTI losses are recorded in the Company’s consolidated statement of operations and non-credit OTTI losses are recorded in other comprehensive income.
The following tables roll forward the amount of credit losses recognized in earnings on debt securities, for which a portion of the OTTI also was recognized in other comprehensive income:
(A Wholly-Owned Subsidiary of Sun Life of Canada (U.S.) Holdings, Inc.)
(1) Excludes $4.3 million of other invested assets that are not subject to FASB ASC Topic 820.
(3) Excludes $648.5 million, primarily related to investment purchases payable, net of investment sales receivable, that are not subject to FASB ASC Topic 820.
(1) The balances are included within the contractholder deposits funds and other policy liabilities in the Company’s consolidated balance sheets.
At December 31, 2011, the Company determined that certain mortgage loans were impaired and as a practical expedient, measured the impairment using the fair value of the related collateral. The fair value of the collateral was based on real estate valuations.
The following table presents the carrying value and estimated fair value of the Company’s financial instruments that are not carried at fair value at:
The Wealth Management segment manages a closed block of SPWL insurance policies, a retirement-oriented tax-advantaged life insurance product. The Company discontinued sales of the SPWL product in response to certain tax law changes in the 1980s. The Company had SPWL policyholder balances of $1.3 billion and $1.5 billion at December 31, 2011 and 2010, respectively. This entire block of business is reinsured on a funds-withheld coinsurance basis with SLOC, an affiliate. Pursuant to this agreement, the Company held the following assets and liabilities at December 31:
SLNY also has a reinsurance agreement, effective May 31, 2007, to assume the net risks of SLHIC’s New York issued contracts. At December 31, 2011 and 2010, SLNY held policyholder liabilities of $25.7 million and $28.6 million, respectively, related to this agreement. In addition, the reinsurance agreement increased revenues by $36.2 million, $47.6 million and $52.9 million for the years ended December 31, 2011, 2010 and 2009, respectively, and increased expenses by $26.2 million, $31.2 million and $44.3 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Prior to the December 31, 2009 employee transfer, the Company sponsored two non-contributory defined benefit pension plans for its employees and certain affiliated employees. These plans were the staff qualified pension plan (“staff pension plan”) and the staff nonqualified pension plan (“UBF plan”) (collectively, the “Pension Plans”). Expenses were allocated to participating companies based in a manner consistent with the allocation of employee compensation expenses. The Company's funding policies for the staff pension plan was to contribute amounts which at least satisfy the minimum amount required by the Employee Retirement Income Security Act of 1974 (“ERISA”). Most pension plan assets consist of separate accounts of SLOC or other insurance company contracts.
The Company accounts for current and deferred income taxes in the manner prescribed by FASB ASC Topic 740. A summary of the components of income tax (benefit) expense in the consolidated statements of operations for the years ended December 31 is as follows:
The following roll-forward summarizes the change in reserve for the Company’s GMDBs and GMIBs for the year ended December 31, 2011:
The following roll-forward summarizes the change in reserve for the Company’s GMDBs and GMIBs for the year ended December 31, 2010:
In the normal course of its business, the Company has entered into agreements that include indemnities in favor of third parties, such as contracts with advisors and consultants, outsourcing agreements, underwriting and agency agreements, information technology agreements, distribution agreements and service agreements. The Company has also agreed to indemnify its directors, officers and employees in accordance with the Company’s by-laws. The Company believes any potential liability under these agreements is neither probable nor estimatable. Therefore, the Company has not recorded any associated liability.