The Company’s home office consists of four office buildings located in Wellesley Hills, Massachusetts. The Company owns this facility and leases it to SLOC under a renewable lease, with terms not exceeding five years. The home office of SLNY consists of office space in New York, New York, and is leased from an unrelated party.
Pursuant to Instruction I (2)(a) to Form 10-K, the Company elects to omit Management’s Discussion and Analysis of Financial Position and Results of Operations. Below is management’s narrative analysis of the Company’s results of operations explaining the reasons of material changes in the Company’s consolidated statements of operations between the years ended December 31, 2011 and December 31, 2010.
Sales inducement asset (“SIA”) represents amounts that are credited to policyholder account balances related to the enhanced or bonus crediting rates that the Company offers on certain of its annuity products. The costs associated with offering the enhanced or bonus crediting rates are capitalized and amortized over the expected life of the related contracts in proportion to the estimated gross profits.
The value of business acquired (“VOBA”) represents the actuarially determined present value of projected future gross profits from in-force policies from acquired businesses. VOBA is amortized in proportion to the projected emergence of profits or premium income over the estimated life of the purchased block of business or the period to the first renewal of the transferred business.
The Company issues annuity contracts, guaranteed investment contracts (“GICs”) and certain funding agreements that contain derivative instruments that are embedded in the contract. Upon issuing the contract, the embedded derivative is separated from the host contract (annuity or GIC) and is carried at fair value.
The following table presents the fair value of Level 3 assets and liabilities as a percentage of total assets and liabilities measured at fair value as of December 31, 2010 (in 000’s):
The Company also uses credit valuation adjustments (“CVAs”) to properly reflect the component of fair value of certain derivative instruments that arises from default risk. CVAs are based on a methodology that primarily uses published credit default swap spreads as a key input in determining an implied level of expected loss over the total life of the derivative contact. When this information is not available, the Company also may utilize credit spreads implied from published bond yields or published cumulative default experience data adjusted for current trends. CVAs may be calculated based on the credit risk of counterparties for asset positions or the Company’s own credit risk for liability positions. The CVAs also take into account contractual factors designed to reduce the Company’s credit exposure to each counterparty, such as collateral and legal rights of offset.
The derivative instrument receivable included in Level 3 relates to certain equity cliquet options. At December 31, 2011 and 2010, the value of these options was $5.2 million and $13.8 million, respectively. The derivative instrument payable included in Level 3 relates to the Company’s agreement with Credit and Repackaged Securities Limited Series 2006-10 Trust (the “CARS Trust”) (see Note 4 of the Company’s consolidated financial statements included in Part II, Item 8 of this annual report on Form 10-K for a discussion of the CARS Trust). At December 31, 2011 and 2010, the value of the derivative instrument payable held in Level 3 was $17.7 million and $27.3 million, respectively. Approximately $9.6 million and $7.0 million of the market gains included in earnings for the years ended December 31, 2011 and 2010, respectively, were related to Level 3 derivative instruments, which were measured using significant unobservable inputs.
Credit Standing Adjustment - This component makes an adjustment that market participants would make to reflect the non-performance risk associated with the embedded derivatives. The adjustment is based on the published credit spread for A- rated corporate bonds, which have ratings that are equivalent to the rating of the Company.
At December 31, 2011 and 2010, the value of embedded derivative liabilities held in Level 3 was $1,408.3 million and $133.9 million, respectively.
The Company determines the fair value of its fixed maturity securities using three primary pricing methods: third-party pricing services, non-binding broker quotes and pricing models. Prices are first sought from third-party pricing services; the remaining unpriced securities are priced using one of the remaining two methods. The Company generally does not adjust quotes or prices obtained from brokers or pricing services. Due to a general lack of transparency in the process that brokers use to develop prices, most valuations that are based on broker prices are classified as Level 3.
For privately-placed fixed maturity securities, fair values are estimated using a fair value model, which takes into account credit spreads for a variety of public and private securities of similar credit risk, maturity, prepayment and liquidity characteristics. A portion of privately placed fixed maturity securities are also priced using market prices or dealer quotes. The Company’s ability to liquidate positions in privately-placed fixed securities could be impacted to a significant degree by the lack of an actively traded market. Although the Company believes that its estimates reasonably reflect the fair value of those instruments, its key assumptions about risk-free interest rates, risk premiums, performance of underlying collateral (if any) and other factors may not reflect those of an active market.
The Company’s fixed maturity securities are classified as either trading or as available-for-sale. The changes in fair value of trading securities are recorded as a component of net investment income. The changes in fair value of available-for-sale securities are recorded in other comprehensive income. Securities which the Company has elected to measure at fair value under FASB ASC Topic 825, “Financial Instruments,” are classified as trading securities. Although classified as trading securities, the Company’s intent is not to sell these securities in the near term.
Reserves held for annuity contracts including group pension and payout annuity payments are calculated using the best-estimate interest and decrement assumptions;
Reserves held for product guarantees on variable annuity products, such as guaranteed minimum death benefits, are equal to a benefit ratio multiplied by the cumulative contract charges earned, plus accrued interest, less contract benefit payments;
Reserves for UL contracts which are held for the coverage of guaranteed benefits (such as riders, conversions from group policies and benefits provided under market conduct settlements) that are greater than the policy account value; and
The Company accounts for current and deferred income taxes and recognizes reserves for income taxes in accordance with FASB ASC Topic 740, “Income Taxes.”
In evaluating the Company’s ability to recover deferred tax assets, the Company considers all available positive and negative evidence including reversals of deferred tax liabilities (taxable temporary differences), projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income and sources of capital gains, the Company utilizes historical and current operating results and incorporates assumptions including the amount of future federal and state pre-tax operating income, the reversal of temporary differences, and the implementation of prudent and feasible tax planning strategies.
The Company’s net (loss) income was $(103.1) million and $134.3 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The significant changes are discussed below.
Total revenues were $524.9 million and $1,914.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. Changes in the components of total revenues are discussed below:
Investment income related to the mark-to-market of the trading portfolio, net realized losses and limited partnership income was $94.9 million and $604.6 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The Company recorded $186.6 million of investment income during the twelve-month period ended December 31, 2011, as compared to $674.2 million during the twelve-month period ended December 31, 2010, related to changes in the market value of the trading portfolio during the respective periods. The $487.6 million decrease in unrealized gains was primarily attributable to increased sales of trading fixed maturity securities during the twelve-month period ended December 31, 2011, as compared to the same period in 2010, resulting in a over $1.0 billion decrease in the Company’s trading portfolio. The increase in sales of trading fixed maturity securities in 2011 was primarily due to the need for cash to pay off certain of the Company’s notes that matured during the year and to pay a return of capital to the Parent. The impact of increased sales was partially offset by an increase in unrealized gains related to a decrease in U.S. Treasury rates in 2011 as compared to 2010. The Company also recognized $(94.6) million and $(67.3) million of realized losses during the twelve-month periods ended December 31, 2011 and 2010, respectively. The $(27.3) million increase in realized losses was primarily due to a losses recognized on the sale of bonds from the trading portfolio, offset by lower write-downs recognized during the twelve-month period ended December 31, 2011, as compared to same period in 2010. The $487.6 million change in the trading portfolio was slightly offset by a $5.2 million increase in the fair value of the Company’s limited partnership investments in 2011, as compared to 2010.
Investment income on funds-withheld reinsurance portfolios is included as a component of net investment income in the Company’s consolidated statements of operations. The Company ceded net investment (loss) income of $(25.2) million and $75.6 million for the twelve-month periods ended December 31, 2011 and 2010, respectively, in connection with the funds-withheld reinsurance agreements between the Company and certain of its affiliates related to the Company’s SPWL and certain of its UL policies. The $(25.2) million net investment loss ceded during the twelve-month period ended December 31, 2011 includes a $113.3 million decrease in net investment income ceded due to an interest rate adjustment on certain of the Company’s SPWL policy loan balances processed during the period. The adjustment did not have any impact on net investment income, net of reinsurance, reported in the Company’s consolidated statement of operations because the SPWL block is 100% reinsured by SLOC on a funds-withheld basis. For further details of this adjustment, refer to Note 8 of the Company’s consolidated financial statements, presented in Part II, Item 8 of this annual report on Form 10-K.
Net derivative loss - was $(988.1) million and $(149.3) million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The Company’s realized and unrealized gains and losses by derivative type for the twelve-month periods ended December 31 consisted of the following (in 000’s):
Out of the $(65.7) million losses related to foreign currency and equity contracts, $(34.3) million relates to foreign currency contracts. The foreign currency loss was primarily due to changes in fair value of the Company’s European Medium Term Note structured product which was a GIC that matured in 2011. The remaining $(31.4) million loss related to equity contracts which was primarily due to changes in fair value of equity options held and the expiration of out-of-the-money equity options.
Fee and other income - were $608.4 million and $511.0 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. Fee and other income consist primarily of mortality and expense charges, rider fees, surrender charges and other income. Mortality and expense charges and rider fees are based on the market values of the assets in the separate accounts supporting the contract. Mortality and expense charges and rider fees combined were $425.5 million and $385.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. Variable product fees represented 1.55% and 1.56% of the average variable annuity separate account balances for the twelve-month periods ended December 31, 2011 and 2010, respectively. Average separate account assets were $27.4 billion and $24.7 billion for the twelve-month periods ended December 31, 2011 and 2010, respectively.
The Company’s interest credited for the twelve-month period ended December 31, 2011 decreased by $113.3 million due to policy reinstatements and an interest rate adjustment on certain of the Company’s SPWL policy loan balances during the period. The adjustment did not have any impact on interest credited, net of reinsurance, reported in the Company’s consolidated statement of operations as the SPWL block is 100% reinsured by SLOC on a funds-withheld basis. For further details of this adjustment, refer to Note 8 of the Company’s consolidated financial statements, presented in Part II, Item 8 of this annual report on Form 10-K.
Interest expense - was $47.2 million and $51.8 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $4.6 million decrease was primarily due to a decrease in interest expense related to unrecognized tax benefits during the twelve-month period ended December 31, 2011, as compared to the twelve-month period ended December 31, 2010 along with the maturity and payment of certain of the Company’s demand notes to affiliates in 2011. For further details on the maturity and payment of the demand notes, refer to Note 3 of the Company’s consolidated financial statements, presented in Part II, Item 8 of this annual report on Form 10-K.
Policyowner benefits - were $134.4 million and $239.8 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $105.4 million decrease in 2011 as compared to 2010, was primarily due to a $122.9 million decrease in SIA amortization and deferrals related to certain variable annuity products and a $10.2 million decrease in annuity payments, offset by a $22.0 million increase in benefits related to an increase in liabilities for group pension and annuities in payout phase, and a $6.0 million increase related to health benefits. The decrease in SIA amortization was primarily due to a decrease in actual gross profits attributable to an increase in the fair value of GMAB and GMWB liabilities during the twelve-month period ended December 31, 2011, as compared to the same period in 2010. The increase in group pension and annuity payout liabilities was primarily due to loss recognition associated with lower yields on the underlying assets.
Amortization of DAC - DAC relates to the costs of acquiring new business, which vary with and are primarily related to the production of new business. Such acquisition costs include commissions, costs of policy issuance and underwriting, and selling expenses. DAC amortization expense was $(276.3) million and $663.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $(939.5) million change in amortization expense during the twelve-month period ended December 31, 2011, as compared to the twelve-month period ended December 31, 2010, was primarily attributable to a $(1,295.3) million decrease in amortization expense, net of interest on the DAC asset and a $(99.4) million decrease in loss recognition charges, partially offset by a $455.2 million increase in unlocking adjustments.
The Company tests its DAC asset for loss recognition on a quarterly basis. The test is performed by comparing the GAAP liability, net of DAC, to the present value of future expected gross profits or gross premium reserves. As a result of the test, the Company recorded loss recognition charges of $18.3 million and $117.7 million to amortization expense in the Wealth Management segment for the years ended December 31, 2011 and 2010, respectively.
These decreases were offset by a $455.2 million increase in unlocking adjustments due primarily to updates to profitability projections resulting from actual changes to in-force policies and assumption changes related to certain fixed annuity products gross profit valuations. At December 31, 2011, the total present value of the gross profit for the largest cohort of the Company’s fixed annuities was negative resulting in a $487.2 million decrease in DAC asset during the twelve-month period ended December 31, 2011.
Other operating expenses - were $350.3 million and $318.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $32.1 million change in 2011, as compared to 2010, was primarily due to a $10.4 million increase in non-deferrable commission expense related to a decrease in ceded commission expense on certain UL policies and a $18.2 million increase in other operating expenses primarily due to severance and other restructuring costs related to the discontinued sales of the Company’s variable annuity and individual life products, as well as an accrual recorded in 2011 for certain guarantee fund assessments. The remaining $3.5 million was attributable to an increase in premium taxes. Refer to Part, I Item 1 of this annual report on Form 10-K for further discussion regarding the Company’s decision to discontinue the sale of variable annuity and individual life products.
The Company’s net (loss) income from operations reflects the operations of its four business segments: Wealth Management, Individual Protection, Group Protection and Corporate.
The segment’s principal products are described below for the years ended December 31, 2011 and 2010:
Variable Annuities - Variable annuities offer a selection of underlying investment alternatives that may satisfy a variety of policyholder risk/return objectives. Under a variable annuity, the policyholder has the opportunity to select separate account investment options (consisting of underlying mutual funds), which pass the investment risk directly to the policyholder in return for the potential of higher returns. Variable annuities also include guaranteed fixed interest options and benefits. The Company has several different variable annuity products that offer various separate account investment choices, depending on the product, and guaranteed fixed interest options. Effective December 30, 2011, the Company discontinued the sales of its variable annuity products. Refer to Part I, Item 1 of this annual report on Form 10-K for further details.
Fixed Index Annuities - Fixed index annuities credit interest to the policyholder using a formula based upon the positive change in value of a specified equity index. The Company’s fixed index annuity products calculate interest earnings using the S&P 500 Index. The Company’s fixed index products also provide a guarantee of principal (less withdrawals) at the end of the term or surrender charge period. Effective January 1, 2010, the Company discontinued the sale of certain of its fixed index annuity products.
The Company uses derivative instruments to manage the risks inherent in the contract options of many of these products.
The Company issued floating rate funding agreements to its affiliates, Sun Life Financial Global Funding III, L.L.C. (“LLC III”), Sun Life Financial Global Funding II, L.L.C. (“LLC II”), and Sun Life Financial Global Funding, L.L.C. (“LLC”). The floating rate funding agreements issued to LLC matured on July 6, 2010, and the floating rate funding agreements issued to LLC II matured on July 6, 2011. The impact of these funding agreements and the detail of payments to LLC and LLC II are described in Note 3 of the Company’s consolidated financial statements presented in Part II, Item 8 of this annual report on Form 10-K.
Other - 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 of at December 31, 2011 and 2010. This entire block of business is reinsured on a funds-withheld, coinsurance basis with SLOC. The impact of the SPWL reinsurance agreement on the Company’s financial statements is discussed in Note 8 of the Company’s consolidated financial statements presented in Part II, Item 8 of this annual report on Form 10-K.
The Company marketed its annuity products through an affiliated wholesale distribution organization, SLFD, and through a variety of unaffiliated retail and wholesale organizations, including securities brokers, financial institutions, insurance agents and financial advisers.
The Company has an agreement with the CARS Trust, whereby the Company is the sole beneficiary of the CARS Trust. The Company has consolidated the CARS Trust in accordance with ASC Topic 810, “Consolidation,” and reports the trust in the Wealth Management segment. The impact of this agreement on the Company’s financial statements is discussed in Note 4 of the Company’s consolidated financial statements presented in Part II, Item 8 of this annual report on Form 10-K.
The following is a summary of operations for the Wealth Management segment for the years ended December 31, (in 000’s):
Total revenues were $313.0 million and $1,761.0 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $1,448.0 million change was primarily due to decreases of $817.4 million in net derivative income, $711.0 million in net investment income and $12.6 million in net realized investment gains in 2011, as compared to 2010. These decreases were offset by an $88.8 million increase in fee and other income, and a $4.2 million increase in premiums and annuity considerations.
Total benefits and expenses were $491.6 million and $1,514.8 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The decrease of $1,023.2 million was primarily due to decreases of $936.0 million and $114.0 million related to DAC and VOBA amortization expense and policyowner benefits, respectively, offset by increases of $19.6 million, $4.1 million and $3.1 million related to interest credited, interest expense and other operating expenses, respectively.
The $114.0 million decrease in policyowner benefits for the twelve-month period ended December 31, 2011, as compared to 2010, was primarily due to decreases of $122.9 million in SIA amortization and deferrals related to certain variable annuity products and $10.2 million in annuity payments. These decreases were offset by a $15.1 million increase in reserves and a $3.8 million increase in death benefits.
The Company maintains reinsurance agreements with affiliates, including agreements with Sun Life Reinsurance (Barbados) No. 3 Corp (“BarbCo 3”), an affiliate, and SLOC. In its agreement with BarbCo 3, the Company cedes all of the risks associated with certain in-force corporate and bank-owned VUL and private placement VUL policies on a combination coinsurance, coinsurance with funds-withheld and a modified coinsurance basis. Future new business also will be reinsured under this agreement. In addition, the Company’s subsidiary, SLNY, has a reinsurance agreement with SLOC under which SLOC will fund so-called “AXXX” reserves attributable to certain UL policies sold by SLNY. Under this agreement, SLNY cedes, and SLOC assumes, on a funds-withheld 90% coinsurance basis certain in-force policies. Future new business also will be reinsured under this agreement.
The following provides a summary of operations for the Individual Protection segment for the years ended December 31 (in 000's):
The increase of $36.2 million in net investment income resulted primarily from a $31.8 million increase in the fair market value of fixed maturity securities in the trading portfolio in 2011, as compared to 2010. The increase in the fair market value of these securities was primarily due to a decrease in U.S. Treasury rates, as well as an increase in the Individual Protection segment’s trading portfolio due to purchases
The decrease of $36.5 million in embedded derivative income primarily resulted from the change in the fair value of the embedded derivative liability in 2011 as compared to 2010, related to certain VUL and UL products that the Company reinsured to certain affiliates. Refer to Note 8 of the Company’s consolidated financial statements included in Part II, Item 8 of this annual report on Form 10-K for further discussion of the impact of the reinsurance agreements noted above on the Individual Protection segment.
The Group Protection segment had pre-tax income of $17.8 million and $20.8 million for year ended December 31, 2011 and 2010, respectively. Total revenues for the year ended December 31, 2011 decreased by $2.4 million, as compared to the year ended December 31, 2010. The decrease in revenues resulted mainly from a decrease of $3.0 million in premiums, offset by an increase of $0.6 million in net investment income.
Total benefits and expenses for the year ended December 31, 2011 increased by $0.6 million in comparison to the year ended December 31, 2010. The increase in benefits and expenses resulted primarily from an increase of $3.3 million in policyowner benefits, offset by decreases in other operating expenses, interest expense and VOCRA amortization expense of $1.9 million, $0.5 million and $0.3 million, respectively.
The increase of $1.8 million in total benefits and expenses was due to an increase in other operating expenses of $10.2 million, offset by an $8.4 million decrease in interest expense. The increase of $10.2 million in other operating expenses resulted primarily from severance and other restructuring costs, as well as an accrual recorded in 2011 for certain guarantee fund assessments. The decrease of $8.4 million in interest expense resulted primarily from an increase in the allocation of interest expense to the operating segments and a decrease in interest expense related to unrecognized tax benefits during the twelve-month period ended December 31, 2011, as compared to the same period in 2010.
Net investment income includes an increase in market value of trading investments of $186.6 million, $674.2 million and $2,086.7 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Net of tax (expense) of $(5.5) million for the year ended December 31, 2009.
Net of tax benefits (expense) of $22.8 million, $13.0 million and $(1.7) million for the years ended December 31, 2011, 2010 and 2009, respectively.
As of December 31, 2011, the total amount of after tax non-credit OTTI losses recorded in the Company’s accumulated other comprehensive income was $6.9 million.
(2) Includes $(62.0) million, $(62.0) million and $(92.1) million related to acquisitions of derivative instruments during the years ended December 31, 2011, 2010 and 2009, respectively.
The Company exchanged $111.8 million of fixed maturity securities and converted $16.0 million of fixed maturity securities to equity securities during the year ended December 31, 2011. Equity securities are reported in the Company’s balance sheets as part of other invested assets. Mortgage foreclosures resulted in a reclassification of $9.0 million from mortgage loans to real estate during the year-ended December 31, 2011. Refer to Note 8 for details of a $107.2 million non-cash adjustment to policy loans during the year ended December 31, 2011.
On December 31, 2009, the Company paid a dividend of all of the issued and outstanding common stock of the Company’s wholly-owned subsidiary, Sun Life Financial (U.S.) Reinsurance Company (“Sun Life Vermont”), to the Company’s sole shareholder, Sun Life of Canada (U.S.) Holdings, Inc. (the “Parent”). This dividend is discussed more fully in Note 2. As a result of the dividend, the Company’s total assets decreased by $2,658.1 million and total liabilities decreased by $2,563.2 million in a non-cash transaction.
Existing legal, business and contractual requirements call for the Company to, among other things, continue accepting limited applications for (1) certain private placement variable annuities until mid-2012, and (2) new employees of corporate-owned life insurance (“COLI”) customers. Subject to these and other existing obligations, the Company has ceased writing all other COLI new business effective January 31, 2012 and all other individual life and annuities new business effective December 30, 2011.
The consolidated financial statements include the accounts of the Company and its subsidiaries. As of December 31, 2011, the Company directly or indirectly owned all of the outstanding shares of SLNY, which issues individual fixed and variable annuity contracts, group life, group disability, group dental and stop loss insurance, and individual life insurance in New York; Independence Life and Annuity Company (“ILAC”), a Rhode Island life insurance company that sold variable and whole life insurance products; Clarendon Insurance Agency, Inc., a registered broker-dealer; SLF Private Placement Investment Company I, LLC; 7101 France Avenue Manager, LLC; Sun MetroNorth, LLC; SLNY Private Placement Investment Company I, LLC; and SL Investment DELRE Holdings 2009-1, LLC.
The Company’s consolidated financial statements also include a variable interest entity (“VIE”) that the Company is required to consolidate. Refer to Note 4 for further information about VIEs.
On December 30, 2009, Sun Life Vermont, which was a subsidiary of the Company at the time, paid a $100.0 million cash dividend to the Company. On December 31, 2009, the Company paid a dividend of all of the issued and outstanding common stock of Sun Life Vermont to the Parent. As a result of this transaction, Sun Life Vermont is no longer the Company’s wholly-owned subsidiary. At December 31, 2009, Sun Life Vermont’s total assets and liabilities were $2,658.1 million and $2,563.2 million, respectively. Sun Life Vermont’s net income for the year ended December 31, 2009 was $105.0 million. As a result of this dividend transaction, the net income and changes in cash flows from the operating activities of Sun Life Vermont for the year ended December 31, 2009 are presented as discontinued operations in these consolidated financial statements.
The Company determines the fair value of its publicly-traded fixed maturity securities using three primary pricing methods: third-party pricing services, non-binding broker quotes and pricing models. Prices are first sought from third party pricing services; the remaining unpriced securities are priced using one of the remaining two methods. Third-party pricing services derive the security prices through recently reported trades for identical or similar securities with adjustments for trading volumes and market observable information through the reporting date. In the event that there are no recent market trades, pricing services and brokers may use pricing models to develop a security price based on future expected cash flows discounted at an estimated market rate using collateral performance and vintages. The Company generally does not adjust quotes or prices obtained from brokers or pricing services.
As required by FASB ASC Topic 320, the Company recognizes an OTTI loss and records a charge to earnings for the full amount of the impairment based on the difference between the amortized cost and fair value of the security, if the Company intends to sell, or if it is more likely than not that it will be required to sell, the impaired security prior to recovery of its cost basis. Otherwise, losses on securities which are other-than-temporarily impaired are separated into two categories: credit loss and non-credit loss. The credit loss portion is charged to the consolidated statements of operations, while the non-credit loss is charged to other comprehensive income. When an unrealized loss on a fixed maturity is considered temporary, the Company continues to record the unrealized loss in other comprehensive income and not in earnings.
Please refer to Note 4 of the Company’s consolidated financial statements for further discussion of the Company’s recognition and disclosure of OTTI loss.
A mortgage loan is considered impaired when it is probable that the principal or interest is not collectible in accordance with the contractual terms of the loan. When a mortgage loan is classified as impaired, allowances for credit losses are established to adjust the carrying value of the loan to its net recoverable amount. The allowance for credit losses are estimated using the present value of expected cash flows discounted at the loan’s effective interest rate or the fair value of the collateral, if the loan is collateral dependent. A specific allowance for loan loss is established for an impaired loan if the present value of expected cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral less cost to sell, is less than the recorded amount of the loan. The full extent of impairment in the mortgage portfolio cannot be assessed solely by reviewing these loans individually. A general allowance for loan loss is established based on an assessment of past loss experience on groups of loans with similar characteristics and current economic conditions. While management believes that it uses the best information available to establish the loan loss allowances, future adjustments may become necessary if economic conditions differ from the assumptions used in calculating them.
Interest income is recorded on the accrual basis. Investments are placed in a non-accrual status when management believes that the borrower's financial position, after giving consideration to economic and business conditions and collection efforts, is such that collection of principal and interest is doubtful. When an investment is placed in non-accrual status, all interest accrued is reversed against current period interest income. Interest accruals are resumed on such investments only when the investments have performed on a sustained basis for a reasonable period of time and when, in the judgment of management, the investments are estimated to be fully collectible as to both principal and interest.
Acquisition costs consist of commissions, underwriting and other costs that vary with and are primarily related to the production of new business. Acquisition costs related to deposit-type contracts, primarily deferred annuity, universal life (“UL”) and guaranteed investment contracts (“GICs”) are deferred and amortized with interest based on the proportion of actual gross profits to the present value of all estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits are composed of net investment income, net realized and unrealized investment gains and losses, life and variable annuity fees, surrender charges, interest credited, policyholder benefits and direct variable administrative expenses.
SIA represents amounts that are credited to policyholder account balances related to the enhanced or bonus crediting rates that the Company offers on certain of its annuity products. The costs associated with offering the enhanced or bonus crediting rates are capitalized and amortized over the expected life of the related contracts in proportion to the estimated gross profits.
DAC amortization is reviewed regularly and adjusted retrospectively through the current period operations when the Company calculates the actual profits or losses and revises its estimate of future gross profits to be realized from deposit-type contracts, including realized and unrealized gains and losses from investments. The Company also tests its DAC asset and SIA for loss recognition on a quarterly basis. The test is performed by comparing the GAAP liability, net of DAC and SIA, to the present value of future expected gross profits or gross premium reserves. The Company’s DAC asset and SIA at December 31, 2011 and 2010 failed the loss recognition test for certain annuity products and the Company, therefore, wrote down DAC asset and the SIA by $21.0 million and $126.0 million during the years ended December 31, 2011 and 2010, respectively. Please refer to Note 13 of the Company’s consolidated financial statements for the Company’s DAC asset and SIA roll-forward.
Prior to December 31, 2009, the Company’s other asset also included property, equipment, leasehold improvements and capitalized software costs. As described in Note 3, effective December 31, 2009, the Company transferred certain property, equipment, leasehold improvements and capitalized software costs to Sun Life Financial (U.S.) Services Company, Inc. (“Sun Life Services”), an affiliate. Depreciation and amortization expenses related to these assets were $1.3 million for year ended December 31, 2009.
Future contract and policy benefit liabilities include amounts reserved for future policy benefits payable upon contingent events, as well as liabilities for unpaid claims due as of the statement date. Such liabilities are established in amounts adequate to meet the estimated future obligations of in-force policies.
Reserves for GMDB and guaranteed minimum income benefits (“GMIB”) are calculated according to the methodology prescribed by the American Institute of Certified Public Accountants (“AICPA”) which is included in FASB ASC Topic 944 “Financial Services- Insurance,” whereby the expected benefits provided by the guarantees are spread over the duration of the contract in proportion to the benefit assessments.
Benefits and expenses related to traditional life, annuity and disability contracts, including group policies, are recognized when incurred in a manner designed to match them with related premium revenue and to spread income recognition over the expected life of the policy. For UL-type and investment-type contracts, expenses include interest credited to policyholders’ accounts and death benefits in excess of account values, which are recognized as incurred.
The fees that the Company receives, which are assessed periodically and recognized as revenue when assessed; and
In April 2011, the FASB issued Accounting Standard Update (“ASU”) 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” which clarifies when a loan modification or restructuring is considered a troubled debt restructuring (“TDR”). In evaluating whether a restructuring constitutes a TDR a creditor must use judgment to determine whether the following exist:
ASU 2011-02 amends FASB ASC Topic 310 “Receivables,” to include financial difficulty indicators (such as debtor default, debtor bankruptcy or concerns about the future as a going concern) that the lender should consider in determining whether a borrower is experiencing financial difficulties. The amendments also clarify that a borrower could be experiencing financial difficulties even though the borrower is not currently in payment default but default is probable in the foreseeable future.
A restructuring that results in an insignificant delay in contractual cash flow is not considered to be a concession.
The amendments in ASU 2011-02 are effective for the first interim or annual period beginning on or after June 15, 2011. These amendments are to be applied retrospectively to modifications occurring on or after the beginning of the annual period of adoption. The Company adopted ASU 2011-2 on July 1, 2011 and the TDR disclosure requirements are included in Note 4 of these consolidated financial statements.
In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force).” The amendments of ASU 2010-29 provide guidance to clarify the acquisition date that should be used for reporting the pro forma financial information disclosures when comparative financial statements are presented. ASU 2010-29 requires a public entity that presents comparative financial statements to disclose revenue and earnings of the combined entity as if the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The amendments also require the supplemental proforma disclosure to include a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly related to the business combination. The Company adopted ASU 2010-29 on January 1, 2011 and will apply this guidance to future business combinations.
In December 2010, the FASB issued ASU 2010-28 “Intangibles-Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force).” The amendments of ASU 2010-28 require reporting units with zero or negative carrying amounts to perform Step 2 of goodwill impairment test if it is more likely than not that a goodwill impairment exists and to consider adverse qualitative factors when performing the impairment test. The Company adopted ASU 2010-28 on January 1, 2011, and the adoption did not have a significant impact on the Company’s consolidated financial statements.
In April 2010, the FASB issued ASU 2010-18, “Receivables (Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset-a consensus of the FASB Emerging Issues Task Force,” which amends FASB ASC Topic 310. The amendments were made to eliminate diversity in practice in accounting for loans that undergo troubled debt restructuring for those loans that have been included in a pool of loans. Under ASU 2010-18, debt modifications that were made for distressed loans included in a pool of loans do not trigger the criteria needed to allow for such loans to be accounted for separately outside of the pool. Upon initial adoption, an entity may make a one-time election to terminate accounting for loans as a pool. The election may be made on a pool-by-pool basis and does not prevent the entity from using pool accounting for loans that will be acquired in the future. The amendments in ASU 2010-18 are effective for the first fiscal quarter ending on or after July 15, 2010. Early adoption is permitted. The Company adopted ASU 2010-18 on September 30, 2010 and such adoption did not have a material impact on the Company’s consolidated financial statements.
In March 2010, the FASB issued ASU 2010-11, “Derivatives and Hedging (Topic 815): Scope Exception Related to Embedded Credit Derivatives,” which provides amendments to FASB ASC Topic 815, “Derivatives and Hedging,” to clarify the embedded credit derivative scope exception included therein. The amendments address how to determine which embedded credit derivative features are considered to be embedded derivatives that should not be analyzed for potential bifurcation and separate accounting under ASC Topic 815. Under ASU 2010-11, only the embedded credit derivative feature created by subordination between financial instruments is not subject to the bifurcation requirements of ASC Topic 815. However, other embedded credit derivative features would be subject to analysis for potential bifurcation even if their effects are allocated to interests in tranches of securitized financial instruments in accordance with those subordination provisions. The following circumstances would not qualify for the scope exception and are subject to the application of ASC Topic 815 requiring the embedded derivatives to be analyzed for potential bifurcation:
In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurement and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements,” which provides amendments to FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” to provide more robust disclosures about the following:
The different classes of assets and liabilities measured at fair value;
On January 1, 2010, the Company adopted the provisions of FASB ASC Topic 860, “Transfers and Servicing,” which were issued in June 2009. These provisions amend and expand disclosures about the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets. FASB ASC Topic 860 amends previously issued derecognition accounting and disclosure guidance and eliminates the exemption from consolidation for qualifying special purpose entities (“QSPEs”); it also requires a transferor to evaluate all existing QSPEs to determine whether they must be consolidated in accordance with the provisions of FASB ASC Topic 860. This guidance is effective for financial asset transfers occurring in fiscal years and interim periods beginning after November 15, 2009. The adoption did not have a material impact on the Company’s consolidated financial statements.
On January 1, 2010, the Company adopted the provisions of FASB ASC Topic 810, “Consolidation,” which were issued in June 2009. This guidance amends previously issued consolidation guidance which affects all entities currently within the scope of FASB ASC Topic 810, including QSPEs, as the concept of these entities was eliminated by FASB ASC Topic 860. This guidance is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2009. The adoption did not have a material impact on the Company’s consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in GAAP and IFRSs,” which changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. Some of the amendments clarify the FASB’s intent about the application of existing fair value measurement requirements, while other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. Many of the requirements in this update are not meant to result in a change in application of the requirements of FASB ASC Topic 820, “Fair Value Measurement,” but to improve upon an entity’s consistency in application across jurisdictions to ensure that GAAP and IFRS fair value measurement and disclosure requirements are described in the same way. The amendments in ASU 2011-04 are effective, on a retrospective basis, for fiscal years and interim periods within those fiscal years beginning after December 15, 2011. The Company will adopt ASU 2011-04 on January 1, 2012 and does not expect its requirements to significantly impact the Company’s consolidated financial statements.
In October 2010, the FASB issued ASU 2010-26, “Financial Services-Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (a consensus of the FASB Emerging Issues Task Force),” which amends FASB ASC Topic 944, “Financial Services-Insurance,” to modify the definition of the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal contracts. The amendments specify that only incremental costs of successful contract acquisition that result directly from and are essential to the contract transactions can be capitalized as deferred acquisition costs. The incremental direct costs are those costs that would not have been incurred by the insurance entity if the contract transactions did not occur. The amendments in ASU 2010-26 are effective for interim periods and fiscal years beginning after December 15, 2011. The Company will adopt ASU 2010-20 on January 1, 2012 and does not expect the adoption of ASU 2010-20 to have a significant impact on its consolidated financial statements.
On December 31, 2009, the Company paid a dividend of all of Sun Life Vermont’s issued and outstanding common stock, and net assets totaling $94.9 million to the Parent. As a result of this transaction, Sun Life Vermont is no longer the Company’s wholly-owned subsidiary. The following table represents a summary of the results of operations for Sun Life Vermont which are included in discontinued operations:
As more fully described in Note 8 to the Company’s consolidated financial statements, the Company and its subsidiary, SLNY, are party to several reinsurance transactions with Sun Life Assurance Company of Canada (“SLOC”) and other affiliates. Reinsurance premiums with related parties are based on market rates.
The Company did not receive any capital contribution from the Parent during the year ended December 31, 2011. During the year ended December 31, 2010, the Company received capital contributions totaling $400.0 million from the Parent. The cash contributions were recorded as additional paid-in capital and were made to ensure that the Company continues to exceed certain regulatory capital requirements established by the National Association of Insurance Commissioners (“NAIC”). The NAIC has established standards for minimum capitalization requirements based on risk-based capital formulas for life insurance companies. The risk-based capital formulas for life insurance companies establish capital requirements relating to insurance, business, asset and interest rate risks, including equity, interest rate and expense recovery risks associated with variable annuities that contain death benefits or certain living benefits.
On September 12, 2006, the Company issued two floating rate funding agreements totaling $900.0 million to Sun Life Financial Global Funding III, L.L.C. (“LLC III”), an affiliate, which will mature on October 6, 2013. On April 7, 2008, the Company issued an additional floating rate funding agreement totaling $5.8 million to LLC III. On December 1, 2011, the Company paid $5.8 million to LLC III due to the maturity of the funding agreement issued to LLC III. Total interest credited for these funding agreements was $5.9 million, $6.2 million, and $11.2 million for the years ended December 31, 2011, 2010 and 2009, respectively. The Company also issued a $100.0 million floating rate demand note payable to LLC III on September 19, 2006. The Company expensed $0.7 million, $0.7 million, and $1.3 million for the years ended December 31, 2011, 2010 and 2009, respectively, for interest on this demand note.
On May 17, 2006, the Company issued a floating rate funding agreement of $900.0 million to Sun Life Financial Global Funding II, L.L.C. (“LLC II”), an affiliate. On April 7, 2008, the Company issued an additional floating rate funding agreement totaling $7.5 million to LLC II. On July 1 and July 19, 2011, the Company paid $901.3 million and $7.5 million, respectively, to LLC II due to the maturity of the funding agreements that the Company issued to LLC II. The payments included $1.3 million in accrued interest. Total interest credited for these funding agreements was $2.6 million, $5.4 million, and $10.5 million for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company also issued a $100.0 million floating rate demand note payable to LLC II on May 24, 2006. On July 19, 2011, the Company paid off the $100.0 million demand note that was due to LLC II. The Company expensed $0.3 million, $0.6 million, and $1.2 million for the years ended December 31, 2011, 2010 and 2009, respectively, for interest on this demand note.
The account values related to these funding agreements issued to LLC III and LLC II are reported in the Company’s consolidated balance sheets as a component of contractholder deposits funds and other policy liabilities.
The following table lists the details of notes due to affiliates at December 31, 2011:
The transfer of fixed assets from the Company to Sun Life Services discussed above, along with the administrative services agreement, resulted in a sale-leaseback transaction. The Company recorded a deposit liability for $17.1 million which represents the cost of certain of the assets transferred. The Company will amortize the liability over the remaining useful life of the transferred assets, which was estimated to be seven years. As of December 31, 2011, the remaining deposit liability was $11.4 million.
The Company has administrative services agreements with SLOC under which SLOC provides, as requested, certain services on a cost-reimbursement basis. Pursuant to the agreements with SLOC, the Company recorded expenses of $14.5 million, $13.0 million and $8.9 million for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company has a service agreement with Sun Life Information Services Ireland Limited (“SLISIL”), under which SLISIL provides various insurance related and information systems services to the Company. Expenses under this agreement amounted to approximately $22.6 million, $23.5 million and $24.2 million for the years ended December 31, 2011, 2010 and 2009, respectively. In addition, SLISIL allocated $0.4 million of severance costs to the Company. These severance costs relate to the decision to discontinue the Company’s variable annuity and individual life products.
The Company has an administrative services agreement with Sun Capital Advisers LLC (“SCA”), an affiliate and a registered investment adviser, under which the Company provides administrative services with respect to certain open-end management investment companies for which SCA serves as the investment adviser, and which are offered to certain of the Company’s separate accounts established in connection with the variable contracts issued by the Company. Amounts received under this agreement amounted to approximately $16.6 million, $13.0 million and $4.3 million for the years ended December 31, 2011, 2010 and 2009, respectively. The Company paid $20.6 million, $21.4 million and $18.2 million for the years ended December 31, 2011, 2010 and 2009, respectively, in investment management services fees to SCA.
The Company paid distribution fees to SLFD of $38.7 million, $41.4 million and $45.4 million, during the years ended December 31, 2011, 2010 and 2009, respectively.
During the year ended December 31, 2009, the Company sold certain limited partnership investments to SLOC with a book value of $16.9 million and a fair market value of $22.4 million. The Company recorded a pre-tax gain on the sales of $5.5 million for the year ended December 31, 2009.
SLNY has a series of agreements with SLHIC, through which substantially all of the New York issued business of SLHIC was transferred to SLNY. As part of these agreements, SLNY received certain intangible assets totaling $31.3 million. These assets included the value of distribution acquired, VOBA, and VOCRA. The value of distribution acquired of $7.5 million is being amortized on a straight-line basis over its projected economic life of 25 years. The amortization expense for the value of distribution acquired was $0.3 million for each of the years ended December 31, 2011, 2010 and 2009.
(1) Represents the pre-tax non-credit OTTI loss recorded as a component of accumulated other comprehensive income (“AOCI”) for assets still held at the reporting date. Recoveries of $9.3 million are shown within gross unrealized gains and the
The amortized cost and fair value of fixed maturity securities held at December 31, 2010 were as follows:
ABS, RMBS and CMBS are shown separately in the table as these securities are not due at a single maturity.
Fixed maturity securities with an amortized cost of approximately $11.8 million and $12.3 million at December 31, 2011 and 2010, respectively, were on deposit with federal and state governmental authorities, as required by law.
The following table shows the fair value and gross unrealized losses, which includes temporary unrealized losses and the portion of non-credit OTTI losses recognized in AOCI, of the Company’s available-for-sale fixed maturity investments, aggregated by investment category and length of time that the individual securities had been in an unrealized loss position at December 31, 2011.
The following table provides the number of securities of the Company’s available-for-sale fixed maturity securities with gross unrealized losses and a portion of non-credit OTTI losses recognized in AOCI aggregated by investment category, at December 31, 2011 (not in thousands):
For those securities where the Company does not have the intent to sell and it is not more likely than not that the Company will be required to sell, the Company employs a portfolio monitoring process to identify securities that are other-than-temporarily impaired. The Company utilizes a Credit Committee, comprised of investment and finance professionals, which meets at least quarterly to review individual issues or issuers that are of concern. In determining whether a security is other-than-temporarily-impaired, the Credit Committee considers the factors described below. The process involves a quarterly screening of all impaired securities.
The Company recorded credit OTTI losses in its consolidated statement of operations totaling $0.1 million and $0.9 million for the years ended December 31, 2011 and 2010, respectively on its available-for-sale fixed maturity securities. The $0.1 million OTTI credit loss recorded during the year ended December 31, 2011 was concentrated in structured securities issued by sponsored securitization vehicles. This impairment was driven primarily by the adverse financial condition of the issuer. The $0.9 million OTTI credit loss recorded during the year ended December 31, 2010 was concentrated in corporate debt of a foreign issuer. This impairment was driven primarily by the adverse financial conditions of the issuer.
The Company is involved with various special purpose entities and other entities that are deemed to be VIEs primarily as a collateral manager and as an investor through normal investment activities or as a means of accessing capital. A VIE is an entity that either has investors that lack certain essential characteristics of a controlling financial interest or lacks sufficient funds to finance its own activities without financial support provided by other entities.
The Company has an agreement with the CARS Trust. Pursuant to this agreement, the Company purchased a funded note from the CARS Trust which, through a credit default swap entered into by the CARS Trust, is exposed to the credit performance of a portfolio of corporate reference entities. The Company entered into this agreement for yield enhancement related to the fee earned on the credit default swap which adds to the return earned on the funded note.
As the sole beneficiary of the CARS Trust, while having a controlling financial interest in the investment vehicle, the Company is required to consolidate the entity under FASB ASC Topic 810. As a result of the consolidation, the Company has recorded in its consolidated balance sheets, investment grade corporate debt securities and a credit default swap held by the CARS Trust. At issue, the swap had a seven-year term, maturing in 2013. Under the terms of the swap, the CARS Trust will be required to make payments to the swap counterparty upon the occurrence of a credit event, with respect to any reference entity, that is in excess of the threshold amount specified in the swap agreement. In the event that the CARS Trust is required to make any payments under the swap, the underlying assets held by the trust would be liquidated to fund the payment. If the disposition of these assets is insufficient to fund the payment calculated, then under the terms of the agreement, the cash settlement amount would be capped at the amount of the proceeds from the sale of the underlying assets. Under the credit default swap, the CARS Trust made a payment of $16.5 million during the twelve-month period ended December 31, 2011; no payment was made during the year ended December 31, 2010. As of December 31, 2011, the cumulative payments that the CARS Trust has made under the credit default swap is $34.1 million, leaving $20.9 million as the maximum future payments that it could be required to make. The carrying amount of the assets in this VIE is included in trading fixed maturity securities and the carrying amount of the liabilities in this VIE is included in the derivative instruments-payable in the Company’s consolidated balance sheets.
In addition, through normal investment activities, the Company makes passive investments in various issues by VIEs. These investments are included in trading and available-for-sale fixed maturity securities, limited partnerships and other invested assets in the Company's consolidated financial statements. The Company has not provided financial or other support with respect to these investments other than its original investments. For these investments, the Company has determined it is not the primary beneficiary due to the size of its investment relative to other issues, the level of credit subordination which reduces its obligation to absorb losses or its right to receive benefits, and/or its inability to direct the activities that most significantly impact the economic performance of the VIEs. The Company's maximum exposure to loss on these investments is limited to the amount of its investment.
Accumulated depreciation on real estate was $50.9 million and $45.6 million at December 31, 2011 and 2010, respectively.
Included in the $1,490.2 million and $1,743.1 million of the Company’s mortgage loans in current status at December 31, 2011 and 2010, were $153.1 million and $165.6 million, respectively, of mortgage loans that are impaired, but not past due.
The Company individually evaluates all its mortgage loans for impairment and records a specific provision for those deemed impaired. The Company also collectively evaluates most of its mortgage loans (excluding those for which a specific allowance was recorded) for impairment. At December 31, 2011, the Company individually and collectively evaluated loans with a gross carrying value of $1,513.8 million and $1,396.1 million, respectively. At December 31, 2010, the Company individually and collectively evaluated loans with a gross carrying value of $1,791.3 million and $1,706.0 million, respectively.
The credit quality indicator for the Company’s mortgage loans is an internal risk rated measure based on the borrowers’ ability to pay and the value of the underlying collateral. The internal risk rating is related to an increasing likelihood of loss, with a low quality rating representing the category in which a loss is first expected. The following table shows the gross carrying value of the Company’s mortgage loans disaggregated by credit quality indicator at December 31:
The following tables show the gross carrying value of impaired mortgage loans and related allowances at:
The average investment in impaired mortgage loans before an allowance for loan loss and the related interest income and cash receipts for interest on impaired mortgage loans for the years ended December 31 were as follows:
The gross carrying value of the Company’s mortgage loans on nonaccrual status was $138.9 million and $114.7 million at December 31, 2011 and 2010, respectively.
Upon adoption of the amendments in ASU 2011-02, the Company reassessed all restructured loans that occurred on or after January 1, 2011, the beginning of its fiscal year, for identification as TDRs. Adoption of the ASU 2011-02 had no impact on the number of restructured loans that are considered TDRs.
Mortgage loans and real estate investments comprise the following property types and geographic regions at December 31:
At December 31, 2011, scheduled mortgage loan maturities were as follows:
The Company had no leveraged lease investments at December 31, 2011 and 2010.
The Company had outstanding commitments to fund limited partnerships of approximately $11.8 million and $12.6 million at December 31, 2011 and 2010, respectively.
The Company does not employ hedge accounting. The Company believes that its derivatives provide economic hedges and the cost of formally documenting hedge effectiveness in accordance with the provisions of FASB ASC Topic 815 is not justified. As a result, all changes in the fair value of derivatives are recorded in the current period operations as a component of net derivative income or loss.
Credit enhancement, such as collateral, is used to improve the credit risk of longer-term derivative contracts.
It is common, and the Company’s preferred practice, for the parties to execute a Credit Support Annex (“CSA”) in conjunction with the International Swaps and Derivatives Association Master Agreement. Under a CSA, collateral is exchanged between the parties to mitigate the market contingent counterparty risk inherent in outstanding positions.
The Company has an agreement with the CARS Trust whereby the Company is the sole beneficiary of the CARS Trust. Please refer to Note 4 of the Company’s consolidated financial statements for additional information regarding the CARS Trust.
In addition to short futures, the Company also utilizes listed put options on major indices to hedge against stock market exposure inherent in the guaranteed minimum death benefit and living benefit features of the Company's variable annuities. Listed options are traded on the stock exchange similar to futures. Unlike futures, however, an up-front premium is paid to or received from the counterparty, instead of depositing an initial cash margin with the Exchange. The Company also purchases listed and OTC call options on major indices to economically hedge its obligations under certain fixed annuity contracts, as well as enhance income on the underlying assets. On the trade date, an initial cash margin is exchanged for listed options. Daily cash is exchanged to settle the daily variation margin.
The following is a summary of the Company’s derivative positions (excluding embedded derivatives) at:
(1) Futures contracts include interest rate, equity price and foreign currency exchange risks. The negative amount represents the Company’s net short position including (45,084) contracts and (33,683) contracts in short position and 10,897 contracts and
7,984 contracts in long position at December 31, 2011 and 2010, respectively.
The aggregate value of all derivative instruments with credit risk-related contingent features that were in a liability position at December 31, 2011 and 2010 was $287.1 million and $362.0 million, respectively. At December 31, 2011, the Company was fully collateralized, substantially mitigating credit risk.
In the event of an early termination, the Company might be required to accelerate payments to counterparties, up to the current value of its net liability positions, after considering the impacts of netting at default. If payments cannot be exchanged simultaneously at early termination, funds also will be held in escrow to facilitate settlement. If an early termination was triggered on December 31, 2011, the Company would be expected to settle a net obligation of $79.1 million.
If counterparties are unable to meet accelerated payment obligations, the Company may also be exposed to uncollectible net asset positions, after considering the impact of netting at default.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. The Company utilizes valuation techniques that maximize the use of observable inputs and minimizes the use of unobservable inputs.
On April 1, 2009, the FASB issued additional guidance on estimating fair value when the volume and level of activity for the asset or liability have significantly decreased, as well as guidance on identifying circumstances indicating that a transaction is not orderly. The Company reviewed its pricing sources and methodologies and has concluded that its various pricing sources and methodologies are in compliance with this guidance. During the year ended December 31, 2011, there were no changes to these valuation techniques and the related inputs.
Financial assets and liabilities recorded at fair value in the Company’s consolidated balance sheets are categorized as follows:
The following table presents the Company’s categories for its assets measured at fair value on a nonrecurring basis at December 31, 2011:
Excludes $5.1 million of other invested assets that are not subject to FASB ASC Topic 820.
Excludes $1,814.1 million, primarily related to investment purchases payable, net of investment sales receivable, that are not subject to FASB ASC Topic 820.
Fixed maturity securities: The Company determines the fair value of its publicly-traded fixed maturity securities using three primary pricing methods: third-party pricing services, non-binding broker quotes and pricing models. Prices are first sought from third-party pricing services; the remaining unpriced securities are priced using one of the remaining two methods. Third-party pricing services derive the security prices through recently reported trades for identical or similar securities with adjustments for trading volumes and market observable information through the reporting date. In the event that there are no recent market trades, pricing services and brokers may use pricing models to develop a security price based on future expected cash flows discounted at an estimated market rate using collateral performance and vintages. The Company generally does not adjust quotes or prices obtained from brokers or pricing services.
Derivative instruments - receivables and payables: The fair values of swaps are based on current settlement values, dealer quotes and market prices. Fair values for options and futures are also based on dealer quotes and market prices. The Company uses credit valuation adjustments (“CVAs”) to properly reflect the component of fair value of certain derivative instruments that arise from default risk. CVAs are based on a methodology that primarily uses published credit default swap spreads as a key input in determining an implied level of expected loss over the total life of the derivative contract. When this information is not available, the Company also may utilize credit spreads implied from published bond yields or published cumulative default experience data adjusted for current trends. CVAs may be calculated based on the credit risk of counterparties for asset positions or the Company's own credit risk for liability positions. The CVAs also take into account contractual factors designed to reduce the Company’s credit exposure to each counterparty, such as collateral and legal rights of offset.
Other policy liabilities: The fair values of S&P 500 Index and other equity-linked embedded derivatives are produced using standard derivative valuation techniques. GMAB and GMWB are considered to be derivatives under FASB ASC Topic 815 and are included in contractholder deposit funds and other policy liabilities in the Company’s consolidated balance sheets. Consistent with the provisions of FASB ASC Topic 820, the Company incorporates risk margins and the Company’s own credit standing, as well as changes in assumptions regarding policyholder behavior, in the calculation of the fair value of embedded derivatives.
Other liabilities: This financial instrument consists of bank overdraft balances which are due to issued checks and transmitted wires that were not cashed and processed in the Company’s bank accounts at the end of the reporting period. Similar to cash, the carrying value for other liabilities approximates fair value due to the liquidity of the balance.
The following table shows a reconciliation of the beginning and ending balances for liabilities which are categorized as Level 3 for the
Gains and losses related to Level 3 assets and liabilities, included in the Company’s consolidated statements of operations for the
The following table shows a reconciliation of the beginning and ending balances for assets which are categorized as Level 3 for the year ended December 31, 2010:
The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities which results in a net zero impact on net income for the Company.
The following table shows a reconciliation of the beginning and ending balances for liabilities which are categorized as Level 3 for the year ended December 31, 2010:
(1) The balances are included within the contractholder deposit funds and other policy liabilities in the Company consolidated balance sheets.
During the year ended December 31, 2011, the Company transferred the following assets into (out of) Levels 1, 2 and 3:
The Company did not change the categorization of its financial instruments during the year ended December 31, 2011. The transfers into (out of) Level 2 and Level 3 were primarily due to changes in the level of observability of inputs used to price these securities.
The Company did not change the categorization of its financial instruments during the year ended December 31, 2010. The transfers into (out of) Level 2 and Level 3 were primarily due to changes in the level of observability of inputs used to price these securities.
The Company’s net investment income consisted of the following for the years ended December 31:
A brief discussion of the Company’s significant reinsurance agreements by business segment follows. Refer to Note 16 for additional information regarding the Company’s business segments.
Reinsurance payable includes a funds-withheld liability of $324.3 million and $326.9 million at December 31, 2011 and 2010, respectively, and a deferred gain of $105.6 million and $105.3 million at December 31, 2011 and 2010, respectively. The funds-withheld assets are managed by the Company and comprised of fixed maturity securities, policy loans, equity securities, cash and cash equivalents and related accrued income, totaling $332.5 million and $357.2 million at December 31, 2011 and 2010, respectively. The funds-withheld coinsurance agreement gives rise to an embedded derivative which is required to be separated from the host reinsurance contract. At December 31, 2011 and 2010, the fair value of the embedded derivative increased contractholder deposit funds and other policy liabilities by $34.1 million and $24.1 million, respectively.
The following table sets forth the components of the net periodic benefit cost and the Company’s share of net periodic benefit costs related to the Pension Plans and the Other Post-Retirement Benefit Plan for the year ended December 31:
For the year ended December 31, 2011, Sun Life Services allocated costs to the Company of $1.2 million and $4.4 million for the Pension Plans and Other Post-Retirement Benefit Plan, respectively. For the year ended December 31, 2010, Sun Life Services allocated costs to the Company of $3.1 million and $4.4 million for the Pension Plans and Other Post-Retirement Benefit Plan, respectively.
The following table shows changes in the Company’s AOCI related to the Pension Plans and the Other Post-Retirement Benefit Plan for the following years:
Effective December 31, 2009, Sun Life Services sponsors a savings plan that qualifies under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”) and in which substantially all employees of at least age 21 at date of hire are eligible to participate. Prior to December 31, 2009, the Company sponsored the 401(k) Plan. Employee contributions, up to specified amounts, are matched by Sun Life Services under the 401(k) Plan.
For RIA participants who were at least age 40 on January 1, 2006 and whose age plus service on January 1, 2006 equaled or exceeded 45, the Company contributed to the RIA from January 1, 2006 through December 31, 2009, and Sun Life Services contributes to the RIA from January 1, 2010 through December 31, 2015, a percentage of the participant’s eligible compensation determined under the following chart based on the participant’s age and service on January 1, 2006.
The amount of the 2009 employer contributions under the 401(k) Plan for the Company and its affiliates was $25.2 million. Amounts are allocated to affiliates based upon their respective employees’ contributions. The Company’s portion of the expense was $14.2 million for the year ended December 31, 2009. For the years ended December 31, 2011 and 2010, Sun Life Services allocated $16.3 million and $17.4 million to the Company, respectively.
The net deferred tax asset represents the tax effects of temporary differences between the carrying amounts of assets and liabilities used for financial reporting purposes and the amounts used for income tax purposes. The components of the Company’s net deferred tax asset as of December 31 were as follows:
The Company’s net deferred tax asset at December 31, 2011 and 2010 was comprised of gross deferred tax assets and gross deferred tax liabilities. The gross deferred tax asset was primarily related to unrealized investment security losses, actuarial liabilities and net operating loss (“NOL”) carryforwards, as well as a capital loss carryforward generated in 2009. At December 31, 2011, the Company had $698.9 million of NOL carryforwards and $20.0 million of capital loss carryforward. At December 31, 2010, the Company had $958.2 million of NOL carryforwards and $33.7 million of capital loss carryforward. If not utilized, the NOL carryforwards will begin to expire in 2023 and the capital loss carryforward will expire in 2014. The Company’s net deferred tax asset was $448.4 million and $394.3 million at December 31, 2011 and 2010, respectively.
During the year ended December 31, 2011, no valuation allowance was recorded against the deferred tax asset for investment losses. The Company believes that it is more likely than not that the deferred tax asset related to impairment losses will be realized due to tax planning strategies related to certain mortgage-backed securities, the Company’s intent and ability to hold the related investment securities to maturity, and other tax planning strategies. For the remaining unrealized losses, the Company believes that it is more likely than not that the related deferred tax asset will be realized due to the Company’s intent and ability to hold the related investment securities to recovery of amortized cost.
FASB ASC Topic 740 establishes a comprehensive reporting model which addresses how a business entity should recognize, measure, present and disclose uncertain tax positions that the entity has taken or plans to take on a tax return.
The Company has elected to recognize interest and penalties accrued related to UTBs in interest expense (income). During the years ended December 31, 2011, 2010 and 2009, the Company recognized $2.6 million, $6.4 million and $(9.0) million, respectively, in gross interest expense (income) related to UTBs. The Company had approximately $9.2 million and $6.6 million of interest accrued at December 31, 2011 and 2010, respectively. During 2010, the Company settled interest assessments of $4.6 million with the Internal Revenue Service (the “IRS”) for the 2001 and 2002 tax years. The Company did not accrue any penalties.
On August 4, 2011, the IRS held an Opening Conference with the Company for the audit of the tax years 2007-2009. The Company is in the process of responding to the IRS requests for information. The Company also provided a disclosure letter to the IRS on September 21, 2011, informing the IRS of potential issues in the tax years under audit.
The Company makes or receives payments under certain tax sharing agreements with SLC - U.S. Ops Holdings. Under these agreements, such payments are determined based upon the Company’s stand-alone taxable income (as if it were filing as a separate company) and based upon the SLC - U.S. Ops Holdings consolidated group’s overall taxable position. Under the terms of the tax sharing agreements, deferred tax assets for tax attributes are realized by the Company when the tax attributes are utilized by the consolidated group. The Company received income tax refunds of $21.0 million and $107.1 million in 2011 and 2010, respectively, and made income tax payments of $21.1 million in 2009.
Activity in the liability for unpaid claims and claims adjustment expenses, which is related to the Company’s and its subsidiaries’ group life, group disability insurance, group dental and group stop loss products is summarized below:
The table below represents information regarding the Company’s variable annuity contracts with guarantees at December 31, 2011:
The table below represents information regarding the Company’s variable annuity contracts with guarantees at December 31, 2010:
(1) Net amount at risk represents the excess of the guaranteed benefits over account balance for contracts that have an account value less than the guarantee.
GMABs and GMWBs are considered to be derivatives under FASB ASC Topic 815 and are recorded at fair value through earnings. The Company records GMAB and GMWB assets or liabilities in its consolidated balance sheets as part of contractholder deposit funds and other policy liabilities. The net balance of GMABs and GMWBs constituted a liability in the amount of $1,286.8 million and $2.3 million at December 31, 2011 and 2010, respectively. The Company includes the following unobservable inputs in its calculation of the embedded derivative:
Actively-Managed Volatility Adjustments - This component incorporates the basis differential between the observable implied volatilities for each index and the actively-managed funds underlying the variable annuity product. The adjustment is based upon historical actively-managed fund volatilities and historical weighted-average index volatilities.
Credit Standing Adjustment - This component makes an adjustment that market participants would make to reflect the non-performance risk associated with the embedded derivatives. The adjustment is based upon the published credit spread for A-rated corporate bonds, which have ratings that are equivalent to the rating of the Company.
The Company tested the VOCRA asset for impairment in the fourth quarter of 2009 and determined that the fair value was lower than its carrying value. Accordingly, the Company decreased the carrying value of VOCRA and recorded an impairment charge of $2.6 million for the year ended December 31, 2009. The impairment charge is included in amortization expense in the consolidated statements of operations and is allocated in the Group Protection segment.
SLUS as Parent’s and SLNY’s net investment income includes an increase in market value of trading investments of $152.4 million and $34.2 million, respectively, for the year ended December 31, 2011. Other Subs’ net investment income does not include trading investments.
SLUS as Parent’s and SLNY’s OTTI losses for the year ended December 31, 2010 represent impairments related to credit loss.
SLUS as Parent’s, SLNY’s and Other Subs’ net investment income includes an increase in market value of trading investments of $1,913.3 million, $173.4 million and $0.0 million, respectively, for the year ended December 31, 2009.
The Wealth Management segment includes funding agreements, individual and group variable annuity products, individual and group fixed annuity products and other retirement benefit products. These contracts may contain any of a number of features including variable or fixed interest rates and equity index options and may be denominated in foreign currencies. The Company uses derivative instruments to manage the risks inherent in the contract options. In addition, the Company consolidates certain VIEs as a component of the Wealth Management segment. Refer to Note 4 for further discussion of the VIE that is consolidated in the Company’s consolidated financial statements. Effective January 1, 2010, the Company discontinued the sales of certain of its fixed and fixed index annuity products. Effective December 30, 2011, the Company discontinued new sales of its variable annuity products. Refer to Note 1 for further details.
The Individual Protection segment includes a variety of life insurance products sold to individuals and corporate owners of life insurance. The products include whole life, UL and variable life products. The Company discontinued the sales of its individual life products and its corporate-owned life insurance effective December 30, 2011 and January 31, 2012, respectively. Refer to Note 1 for further details.
The Group Protection segment includes group life, group long-term disability, group short-term disability, group dental and group stop loss insurance products to small and mid-size employers in the State of New York through the Company’s subsidiary, SLNY.
The Company and its insurance subsidiaries are required to file annual statements with state regulatory authorities prepared on a statutory accounting basis prescribed or permitted by such authorities. As of December 31, 2009, the Company received permission from the Commissioner of Insurance of the State of Delaware to admit the equity value of its subsidiary, ILAC, without requiring audited financial statements because ILAC is not required to prepare audited financial statements under Rhode Island’s Annual Financial Reporting regulation.
Statutory surplus differs from stockholder's equity reported in accordance with GAAP primarily because policy acquisition costs are expensed when incurred, policy liabilities are based on different assumptions, investments are valued differently and deferred income taxes are calculated differently. The Company’s statutory financials are not prepared on a consolidated basis.
In 2011, after receiving prior approval from the Delaware Commissioner of Insurance, the Company paid a $300.0 million return of capital to the Parent. In 2010 and 2009, the Company did not pay any cash dividends to the Parent. However in 2009, with regulatory approval, the Company distributed Sun Life Vermont’s net assets and issued and outstanding common stock, totaling $94.9 million in the form of a dividend to the Parent, with regulatory approval.
New York law permits a domestic stock life insurance company to distribute a dividend to its shareholders without prior notice to the New York Superintendent of Financial Services, where the aggregate amount of such dividends in any calendar year does not exceed the lesser of: (i) ten percent of its surplus to policyholders as of the immediately preceding calendar year; or (ii) its net gain from operations for the immediately preceding calendar year, not including realized capital gains. SLNY is permitted to pay dividends up to a maximum of $1.9 million in 2012 without prior approval from the superintendent. No dividends were paid by SLNY during 2011, 2010 or 2009.
Rhode Island law requires prior regulatory approval for any dividend where the amount of such dividend paid during the preceding twelve-month period would exceed the lesser of (i) ten percent of the insurance company’s surplus as of the December 31 next preceding, or (ii) its net gain from operations, not including realized capital gains, for the immediately preceding calendar year, excluding pro rata distributions of any class of the insurance company’s own securities. ILAC is permitted to pay dividends up to a maximum of $2.1 million in 2012 without prior approval from the Rhode Island Superintendent of Insurance. No dividends were paid by ILAC during 2011, 2010 or 2009.
Under insurance guaranty fund laws in each state, the District of Columbia and Puerto Rico, insurers licensed to do business can be assessed by state insurance guaranty associations for certain obligations of insolvent insurance companies to policyholders and claimants. Most of these laws provide, however, that an assessment may be excused or deferred if it would threaten an insurer's solvency and further provide annual limits on such assessments. In addition, part of the assessments paid by the Company pursuant to these laws may be used as credits for a portion of the associated premium taxes. During the twelve month-period ended December 31, 2011, the Company recorded a $9.3 million accrual for guaranteed fund assessments.
The Company was party to a guarantee agreement under which the Company guaranteed the lease payment obligations of SLFD. The lease agreement was terminated and the Company was not required to pay or accrue any of the lease termination costs.
During the first quarter of 2012, the Company and its wholly-owned subsidiary, SLNY, received all necessary insurance regulatory approvals to amend the fixed investment option period in their combination fixed and variable annuity contracts and other contracts to remove any negative market value adjustment (“MVA”) that can decrease the amount of the withdrawal proceeds. (Refer to Note 15 for additional information concerning the MVA and the fixed investment option period). The Company and SLNY filed amendments to the necessary registration statements to include the contract amendments and to remove from registration any fixed investment options that remained unsold. The SEC declared the associated amended registration statements effective on March 22, 2012. As a result of the foregoing, the fixed investment option period in the contracts is no longer considered a “security” under the Securities Act of 1933, and the Company subsequently filed Forms 15 on March 23, 2012 to provide notice of suspension of its duty to file reports under Section 15(d) of the Securities Exchange Act of 1934. No other changes were made to the contracts, and all other terms and conditions of the contracts remain unchanged. The MVA amendment described above did not have a material impact on the Company’s financial position.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sun Life Assurance Company of Canada (U.S.) and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.