The Private Securities Litigation Reform Act of 1995 defines forward-looking statements as statements not based on historical fact and provides a safe harbor for such statements. This discussion may include forward-looking statements by the Company. These statements may relate to such topics as product sales, volume growth, market share, market and interest rate risk, and financial goals. It is important to understand that such forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those that the statements anticipate, including but not limited to the risks discussed in Part I, Item 1A of this annual report on Form 10-K.
The following table presents the fair value of assets and liabilities, as categorized in the Company’s fair value hierarchy as of December 31, 2009 (in 000’s):
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, 2009 (in 000’s):
The Company also holds derivatives which are embedded in its insurance contracts. The Company includes the following unobservable inputs in its calculation of the embedded derivatives:
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 and fixed index annuity products. The adjustment is based on 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 on the published credit spread for AA- rated corporate bonds, which have ratings that are equivalent to the rating of the Company.
The following table presents the fair value of fixed maturity securities by pricing source and the categorization in the Company’s fair value hierarchy as of December 31, 2009 (in 000’s).
Structured securities are priced using third-party pricing services, a fair value model or independent broker quotes. CMBS are priced using the last sale price of the day or a broker quote, if no sales were transacted that day. ABS are priced using pricing models or independent broker quotations. Typical inputs used by these three pricing methods include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids and/or estimated cash flows and prepayment speeds. In addition, estimates of expected future prepayments are factors in determining the price of ABS, RMBS, and CMBS. These estimates are based on the underlying collateral and structure of the security, as well as prepayment speeds previously experienced in the market at interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates.
At December 31, 2009, $282.3 million of structured securities were classified as Level 3, representing 68.3% of the Company’s total Level 3 fixed maturity securities and 12.8% of the total structured securities at December 31, 2009.
The Company validates the prices obtained from its third-party pricing services quarterly through a variety of methods, including subjecting prices to a tolerance range based on market conditions. The Company performs further testing on those securities whose prices do not fall within the pre-established tolerance range. This testing includes looking at specific market events that may affect pricing or obtaining additional information or new prices from a third-party pricing service. Additionally, the Company makes a selection of securities from its portfolio and compares the price received from its third-party pricing services to an independent source, creates option adjusted spreads for each security, or obtains additional broker quotes to corroborate the current market price. At December 31, 2010, the Company found no material variances between the prices received from third-party pricing sources and the results of its testing.
The Company's accounting policy for impairment requires recognition of other-than-temporary impairment (“OTTI”) write-downs in accordance with FASB ASC Topic 320 “Fair Value Measurement and Disclosure.” An OTTI loss is recognized and recorded as a charge to earnings for the full amount of the impairment (the difference between the current carrying amount 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, namely, credit loss and non-credit loss. The credit loss portion is charged to net realized investment gains (losses) in 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 1 and Note 4 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 Company’s recognition and disclosure of OTTI loss.
The Company’s policy 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 policies in force. Policy liabilities also are comprised of:
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 universal life 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’s net income was $134.3 million and $981.5 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The significant changes are discussed below.
Total revenues were $1,914.2 million and $3,021.0 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. Changes in the components of total revenues are discussed below:
The change in investment income related to net realized gains (losses) and changes in the mark-to-market of the trading portfolio was $(1,130.2) million. The Company recognized $674.2 million and $2,086.7 million of investment income due to changes in the fair value of the trading portfolio during the twelve-month periods ended December 31, 2010 and 2009, respectively. The decrease in investment income in 2010 as compared to 2009, related to the change in market value of the Company’s trading portfolio during the twelve-month period ended December 31, 2010, as compared to the twelve-month period ended December 31, 2009, was primarily due to the significant tightening of credit spreads and change in interest rates as market conditions improved during the twelve-month period ended December 31, 2009, resulting in a significant increase in market value and the recovery of unrealized losses in the portfolio from 2008. The credit spread tightening and change in interest rates were less significant during the twelve-month period ended December 31, 2010, which resulted in a smaller increase in the market value of the Company’s trading portfolio. The Company also recognized $(67.3) million and $(349.6) million of realized losses during the twelve-month periods ended December 31, 2010 and 2009, respectively. The $282.3 million decrease in realized losses was primarily due to lower write-downs recognized during the twelve-month period ended December 31, 2010, as compared to same period in 2009. The $(1,130.2) million change in the trading portfolio was slightly offset by a $6.9 million increase in the fair value of the Company’s limited partnership investments.
Net derivative loss - was $(149.3) million and $(39.9) million for the twelve-month periods ended December 31, 2010 and 2009, 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):
The $(266.1) million change in net derivative loss during the twelve-month period ended December 31, 2010 as compared to the twelve-month period ended December 31, 2009, related to interest rate contracts was primarily due to interest rate swap contracts. Interest rate swap contracts are agreements to exchange with a counterparty interest rate payments of differing character (e.g., fixed-rate payments exchanged for floating-rate payments) based on an underlying principal balance (notional principal) to hedge against interest rate changes. The $(122.7) million loss in 2010 as compared to the $143.4 million gain in 2009 was attributable to the (decrease) increase in the fair value of interest rate swaps resulting from changes in notional amounts, duration and the overall swap curve. The decrease in the fair value of interest rate contracts for the twelve-month period ended December 31, 2010, as compared to the twelve-month period ended December 31, 2009, was primarily a result of a change in interest rates.
Net realized investment gains (losses), excluding impairment losses on available-for-sale securities - were $27.0 million and $(36.7) million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The $27.0 million realized gains during the twelve-month period ended December 31, 2010, were primarily attributable to $37.4 million gain on sales of available-for-sale fixed maturity securities, offset by an $(11.0) million loss related to net provisions for estimated losses on mortgage loans. The $(36.7) million realized losses during the twelve-month period ended December 31, 2009, was primarily due to $(38.8) million loss associated with net provisions for estimated losses on mortgage loans offset by gains on sales of available-for-sale fixed maturity securities.
Other-than-temporary impairment losses - were $(0.9) million and $(4.8) million for the twelve-month periods ended December 31, 2010 and 2009, respectively, related to available-for-sale fixed maturity securities. The OTTI losses for the twelve-month period ended December 31, 2010 relate to credit losses and were recorded to earnings in accordance with certain aspects of FASB ASC Topic 320 that the Company adopted on April 1, 2009, as described 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 Company did not incur any OTTI losses related to other factors during the twelve-month period ended December 31, 2010 and therefore did not recognize OTTI losses in other comprehensive income.
Total benefits and expenses were $1,708.7 million and $1,808.8 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The decrease of $100.1 million was primarily due to the following:
Interest credited - to policyholders was $401.8 million and $385.8 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The increase of $16.0 million was primarily due to decrease in capitalized interest, net of SIA amortization expense related to certain fixed annuity products, which increased interest credited by $64.7 million. The increase was partially offset by a lower average crediting rate, decreasing interest credited by $26.2 million, as well as lower average policyholder balances which decreased interest credited by $22.5 million.
Interest expense - was $51.8 million and $39.8 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The $12.0 million increase was primarily due to an increase in interest expense related to unrecognized tax benefits during the twelve-month period ended December 31, 2010, as compared to the twelve-month period ended December 31, 2009.
Policyowner benefits - were $239.8 million and $110.4 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The $129.4 million increase in 2010, as compared to 2009, was primarily due to a $168.4 million increase related to an increase in reserves, a $21.7 million increase in SIA amortization and deferrals related to certain variable annuity products and a $1.0 million increase in surrender benefits. The increases to policyowner benefits were offset by a $48.7 million decrease in death benefits and a $13.0 million decrease in health benefits. Reserves increased (decreased) by $19.3 million and $(149.1) million during the twelve-month periods ended December 31, 2010 and 2009, respectively. The change in reserves was mainly attributable to reserves for guaranteed minimum death benefits (“GMDB”) on variable annuity products. The increase (decrease) in GMDB reserves represents the change in the difference between guaranteed benefits and variable annuity account value balances. The decrease in GMDB reserves during the twelve-month period ended December 31, 2009 was due to the decrease in the difference between guaranteed benefits and variable annuity account value balances. The decrease was primarily driven by the improvement in the equity markets and market volatility during that period.
The remaining net decrease relates to a $209.1 million decrease in loss recognition, offset by a $49.1 million increase in unlocking adjustments in 2010 as compared to 2009. 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. The Company concluded that the GAAP liability, net of DAC, for certain annuity products at December 31, 2010 and 2009 was lower than the present value of future expected gross profits of these products and recorded loss recognition charges of $117.7 million and $326.9 million to amortization expense in the Wealth Management segment for the years ended December 31, 2010 and 2009, respectively.
The $49.1 million increase in unlocking adjustments related to decreases in estimated gross profits was driven by updates to profitability projections due to actual changes to in-force policies, assumption changes and model changes primary related to variable annuity products.
Amortization of VOBA and VOCRA - relates to the actuarially-determined value of in-force business from the Company’s acquisition of Keyport Life Insurance Company (“Keyport”) and agreements between Sun Life and Health Insurance Company (U.S.) (“SLHIC”), an affiliate, and SLNY, under which SLNY agreed to assume direct responsibility for all sales and administration of existing and new business issued by SLHIC in New York (collectively the “SLHIC to SLNY asset transfer”). This amount is amortized in proportion to the projected emergence of profits or premium income over the estimated lives of the underlying contracts. Amortization was $33.9 million and $11.0 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The change was primarily due to current year amortization on VOBA assets for certain fixed annuity products. The Company did not record any amortization expense for the twelve-month period ended December 31, 2009. At December 31, 2009, the Company reached the cap for its VOBA asset related to certain fixed and fixed index annuity products and reported the VOBA asset for these products at historical accumulated deferrals, plus interest.
The Company’s net income from operations reflects the operations of its four business segments: Wealth Management, Individual Protection, Group Protection and Corporate.
The Wealth Management segment sells a full range of retirement-oriented annuity products that provide fixed, indexed or variable returns to policyholders. Annuities are insurance products designed to offer individuals protection against the risk of outliving their financial assets during retirement. Annuities offer a tax-deferred means of accumulating savings for retirement needs and provide a source of income in the payout period. The Company earns spread income from fixed and indexed annuities; variable annuities primarily produce fee income. This segment also markets funding agreements to both related and unrelated third parties.
Fixed Annuities - Fixed annuity products are primarily single premium deferred annuities (“SPDA”). An SPDA policyholder typically makes a single premium payment at the time of issuance. The Company obligates itself to credit interest to the policyholder's account at a rate that is guaranteed for an initial term and is reset annually thereafter for certain of the Company’s annuity products, subject to a guaranteed minimum rate. The Company discontinued the sale of certain of its fixed annuity 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. The impact of these funding agreements and the detail of payments to this LLC are is 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 $1.5 billion at December 31, 2010 and 2009. 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 markets 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 decrease of $1,066.6 million in net investment income resulted primarily from a $1,361.9 million decrease in the fair market value of fixed maturity securities in the Wealth Management segment’s trading portfolio in 2010, as compared to 2009. This decrease in the fair market value was primarily due to the significant tightening of credit spreads and change in interest rates during the twelve-month period ended December 31, 2009, resulting in a significant increase in market value, as compared to a less pronounced spread tightening during the twelve-month period ended December 31, 2010 which resulted in a smaller increase in the market value of the trading portfolio. The decrease was partially offset by decreases in realized losses due to lower write-downs in 2010, as compared to 2009, and ceded investment income related to the reinsurance of the SPWL policies to SLOC.
Total benefits and expenses were $1,514.8 million and $1,623.6 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The decrease of $108.8 million was primarily due to a $334.2 million decrease in DAC and VOBA amortization expense, offset by increases of $138.6 million, $38.8 million, $33.1 million and $14.8 million related to policyowner benefits, other operating expenses, interest expense and interest credited, respectively.
The $38.8 million increase in other operating expenses was primarily due to an increase in non-deferrable commission expense which was attributable to an increase in sales in certain variable annuity products, as well as an increase in advertising expenses related to the Company’s branding campaign. The $33.1 million change in interest expense was attributable to an increase in interest expense allocated to the Wealth Management segment during the twelve-month period ended December 31, 2010, relative to the same period in 2009.
The $14.8 million increase in interest credited was primarily the result of a decrease in capitalized interest, net of SIA amortization expense, related to certain fixed annuity products which increased interest credited by $64.8 million, offset by a lower average crediting rate coupled with lower average policyholder balances which decreased interest credited by $50.0 million.
The Individual Protection segment sells individual UL and variable life insurance products, including VUL, to individuals and corporate-owned life insurance (“COLI”) and bank-owned life insurance (“BOLI”) to employers. UL products allow for flexible premiums and feature an investment return to policyholders at a specified rate declared by the Company. VUL products allow for flexible premiums and variable rates of investment return; the policyholder directs how the cash value is invested and bears the investment risk.
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 Company maintains, through SLNY, a reinsurance agreement with SLHIC pursuant to which SLNY assumes the net risks associated with substantially all of the existing and future new business issued by SLHIC in New York. In addition, SLNY and SLHIC are parties to a renewal rights agreement under which SLNY has exclusive rights to renew SLHIC in-force business assumed under the reinsurance agreement.
Total benefits and expenses for the year ended December 31, 2010 decreased by $12.8 million in comparison to the year ended December 31, 2009. The decrease in benefits and expenses resulted primarily from decreases in policyowner benefits, VOBA and VOCRA amortization, and other operating expenses of $8.1 million, $3.6 million and $1.7 million, respectively.
The $31.3 million decrease in total revenues was primarily due to decreases of $76.0 million and $27.5 million in net investment income and derivative income, respectively, offset by increases of $55.6 million and $12.9 million in net realized investment gains and fee and other income, respectively. Additionally, the Corporate Segment had a $3.7 million decrease in OTTI credit losses.
The decrease of $76.0 million in net investment income resulted primarily from a change in the allocation of net investment income to the operating segments, decreasing net investment income by $78.2 million. This decrease was offset by an increase of $2.2 million in limited partnership and other investment income. The decrease of $27.5 million in derivative income was primarily related to the decrease in fair value of interest rate swap agreements.
The increase of $55.6 million in net realized investment gains primarily resulted from an increase in net realized gains from available-for-sale fixed maturity securities of $29.9 million and a decrease in net provisions for estimated losses on mortgage loans by $27.2 million. The increase of $12.9 million in fee and other income resulted primarily from increased management fees from an affiliated company.
The income tax benefit for the year ended December 31, 2010 was primarily due to the tax benefit on the pre-tax loss incurred for the year ended December 31, 2010 and a low income housing credit, offset by the tax effect of non-deductible expenses. The income tax benefit for the year ended December 31, 2009 was primarily due to the tax benefit on the pre-tax loss incurred for the year ended December 31, 2009, as well as the release of the recorded valuation allowance against deferred tax assets for impairment losses on investment assets.
Net of tax expense (benefit) of $13.0 million, $(1.7) million and $(13.8) million for the years ended December 31, 2010, 2009 and 2008, respectively.
As of December 31, 2010, the total amount of after tax non-credit OTTI losses recorded in the Company’s accumulated other comprehensive income was $8.0 million.
Sun Life Assurance Company of Canada (U.S.) (the “Company”) is a stock life insurance company incorporated under the laws of Delaware. The Company is a direct wholly-owned subsidiary of the Parent, which in turn is wholly-owned by Sun Life Financial Inc. (“SLF”), a reporting company under the Securities Exchange Act of 1934. Accordingly, the Company is an indirect wholly-owned subsidiary of SLF. SLF and its subsidiaries are collectively referred to herein as “Sun Life Financial.”
On December 30, 2009, Sun Life Vermont, which was a subsidiary of the Company at the time, paid a $100 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 and was not included in the Company’s consolidated balance sheet at December 31, 2009. As of 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 (loss) for the years ended December 31, 2009 and 2008 was $105.0 million and $(109.3) million, respectively. As a result of this dividend transaction, the net income (loss) and changes in cash flows from the operating activities of Sun Life Vermont for the year ended December 31, 2009 and 2008 are presented as discontinued operations in these consolidated financial statements.
To determine the nature of the Company’s interest in a VIE, it performs an assessment of each party’s interest in the VIE beyond any voting interest that it may have. This assessment looks to sufficiency of an equity investment at risk in terms of the entity’s ability to self-finance its activities, as well as other indicators of control including the power to direct activities that impact economic performance, the obligation to absorb expected losses, and the right to receive expected returns. The Company is deemed to control a VIE when it has both the ability to direct the activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. If the Company determines that it is the VIE’s primary beneficiary, the VIE must be consolidated in the Company’s consolidated financial statements. At December 31, 2010, the Company had no variable interest in significant VIEs for which disclosure is required under FASB ASC Topic 810.
All intercompany 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, other-than-temporary impairments of investments, allowance for loan loss and valuation allowance on deferred tax assets. Actual results could differ from those estimates.
Structured securities, such as asset-backed securities (“ABS”) including collateralized debt obligations, residential mortgage-backed securities (“RMBS”) and commercial mortgage-backed securities (“CMBS”) are priced using a fair value model or independent broker quotations. ABS and RMBS are priced using fair value models and independent broker quotations. CMBS securities are priced using the last sale price of the day or a broker quote, if no sales were transacted that day. Typical inputs used by these three pricing methods include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids and/or estimated cash flows and prepayment speeds. In addition, estimates of expected future prepayments are factors in determining the price of ABS, RMBS and CMBS. These estimates are based on the underlying collateral and structure of the security, as well as prepayment speeds previously experienced in the market at interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates.
For privately-placed fixed maturity securities, fair values are determined using a discounted cash flow model which includes estimates that take into account credit spreads for publicly traded securities of similar credit risk, maturity, prepayment and liquidity characteristics. A portion of privately-placed fixed maturity securities also are priced using market prices or broker quotes. The fair values of mortgages are estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between knowledgeable, unrelated willing parties using inputs, including estimates and assumptions, a market participant would utilize. The Company performs a monthly analysis on the prices received from third parties to assess if the prices represent a reasonable estimate of the fair value. In addition, on the quarterly basis, the Company performs quantitative and qualitative analysis that includes back testing of recent trades, review of key assumptions such as spreads, duration, and credit rating, and on-going review of third-party pricing services’ methodologies. The Company performs further testing on those securities whose prices do not fall within a pre-established tolerance range. This testing includes looking at specific market events that may affect pricing or obtaining additional information or new prices from the third-party pricing service. Additionally, the Company makes a selection of securities from its portfolio and compares the price received from its third-party pricing services to an independent source, creates option adjusted spreads or obtains additional broker quotes to corroborate the current market price. Historically, the Company has found no material variances between the prices received from third-party pricing sources and the results of its testing.
Please refer to Note 5 of the Company’s consolidated financial statements for further discussion of the Company’s fair value measurements.
With the adoption of the provisions of FASB ASC Topic 320, the Company recognizes an OTTI loss and records a charge to earnings for the full amount of the impairment (the difference between the current carrying amount 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 net realized investment gains (losses) in 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.
The Company discontinues the accrual of income on its holdings for issuers that are in default. The Company’s net investment income would have increased by $4.6 million and $4.3 million for the year ended December 31, 2010 and 2009, respectively, if these holdings were performing. As of December 31, 2010 and 2009, the fair market value of holdings for issuers in default was $53.9 million and $26.0 million, respectively.
Mortgage loans are stated at unpaid principal balances, net of provisions for estimated losses. Mortgage loans acquired at a premium or discount are carried at amortized cost using the effective interest rate method, net of provisions for estimated losses. Purchases and sales of mortgage loans are recognized or derecognized in the Company’s balance sheet on the loans’ trade dates, which are the dates that the Company commits to purchase or sell the loan. Transaction costs on mortgage loans are capitalized on initial recognition and are recognized in the Company’s statement of operations using the effective interest method. Mortgage loans, which primarily include commercial first mortgages, are diversified by property type and geographic area throughout the United States. Mortgage loans are collateralized by the related properties and generally are no more than 75% of the property’s value at the time that the original loan is made. The Company regularly assesses the value of the collateral.
Realized gains and losses on the sales of investments are recognized in operations at the date of sale and are determined using the average cost method. Changes in the provision for estimated losses on mortgage loans and real estate are included in net realized investment gains and losses.
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 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.
The DAC asset under GAAP cannot exceed accumulated deferrals, plus interest. At December 31, 2009 and 2008, the Company reached the cap for its DAC asset and SIA related to certain fixed and fixed index annuity products and reported the DAC asset for these products at historical accumulated deferrals with interest. At December 31, 2010, the Company’s SIA related to certain fixed and fixed index annuity remained at historical accumulated deferral with interest. However, the Company’s DAC related to certain fixed and fixed index annuities was below the cap and regular amortization was recorded during the year.
Although recovery of VOBA is not assured, the Company believes it is more likely than not that all of these costs will be recovered from future profits. The amount of VOBA considered recoverable could be reduced in the near term, however, if the future estimates of gross profits are reduced.
The Company’s other assets are comprised primarily of receivables from affiliated companies, outstanding premiums, and intangible assets. Intangible assets consist of state insurance licenses that are not subject to amortization and the value of distribution. The value of distribution represents the present value of projected future profits arising from sales of new business by brokers with whom SLHIC had an existing distribution relationship contract. This amount is amortized on a straight-line basis over 25 years, representing the period over which the Company expects to earn premiums from new sales stemming from the added distribution capacity.
Policy reserves for annuity contracts include liabilities held for group pension and payout annuity payments and liabilities held for product guarantees on variable annuity products, such as guaranteed minimum death benefits (“GMDB”). Reserves for pension and payout annuity contracts are calculated using the best-estimate interest and decrement assumptions. The Company periodically reviews its policies for loss recognition based upon management’s best estimates. During the year ended December 31, 2010, the Company recorded a $29.2 million adjustment to reserves related to loss recognition. The Company did not record any adjustment to reserves related to loss recognition for the year ended December 31, 2009.
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.
Contractholder deposit funds consist of policy values that accrue to the holders of universal life-type contracts and investment-related products such as deferred annuities, single premium whole life (“SPWL”) policies, GICs and funding agreements. The liabilities consist of deposits received plus interest credited, less accumulated policyholder charges, assessments, partial withdrawals and surrenders. The liabilities are not reduced by surrender charges.
Under the applicable asset and liability method for recording deferred income taxes, deferred taxes are recognized when assets and liabilities have different values for financial statement and tax reporting purposes, using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Valuation allowances on deferred tax assets are estimated based on the Company’s assessment of the realizability of such amounts. Please refer to Note 10 of the Company’s consolidated financial statements for further discussion of the Company’s income taxes.
The activity related to the GMDB, GMIB, guaranteed minimum accumulation benefit (“GMAB”) and guaranteed minimum withdrawal benefit (“GMWB”), which is reflected in the Company’s consolidated financial statements.
In July 2010, the FASB issued Accounting Standard Update (“ASU”) 2010-20, “Receivables (Topic 310): Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” which amends FASB ASC Topic 310 to enhance disclosures and to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. The amendments require an entity to provide a greater level of disaggregated information about the credit quality of the entity’s financing receivables and allowance for credit losses. ASU 2010-20 also requires an entity to disclose credit quality indicators, the aging of past due information and the modification of its financing receivables. The amendments in ASU 2010-20 that relate to disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. However, the disclosure about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. Comparative disclosures are required for reporting periods ending after initial adoption. The Company adopted ASU 2010-20 on December 31, 2010. The enhanced disclosures required by ASU 2010-20 for the period ending on December 31, 2010, are included in Note 4 of the Company’s consolidated financial statements.
The holder owns an interest in a single-tranche securitization vehicle; therefore, the subordination of one tranche to another is not relevant.
The amendments in ASU 2010-11 are effective for the first fiscal quarter beginning after June 15, 2010. Early adoption is permitted. The Company adopted ASU 2010-11 on July 1, 2010 and such adoption did not have a material impact on the Company’s consolidated financial statements.
In February 2010, the FASB issued ASU No. 2010-09 “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements” which removes the requirement for U.S. Securities and Exchange Commission (“SEC”) filers to disclose the date through which subsequent events have been evaluated. ASU No. 2010-09 is effective upon issuance. Events that have occurred subsequent to December 31, 2010 have been evaluated by the Company’s management in accordance with ASU No. 2010-09.
Certain new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 31, 2009. Disclosures about purchases, sales, issuances and settlements in the roll-forward of activities in Level 3 are effective for fiscal years beginning after December 15, 2010. The Company adopted ASU 2010-06 on January 1, 2010. The enhanced disclosures required by ASU 2010-06 for the periods beginning after December 31, 2009 are included in Note 5 of the Company’s consolidated financial statements.
The Company adopted the provisions of FASB ASC Topic 320, which were issued in April 2009. This guidance amends the guidance for OTTI of debt securities and changes the presentation of OTTI in the financial statements. If the Company intends to sell, or if it is more likely than not that it will be required to sell, an impaired security prior to recovery of its cost basis, the security is to be considered other-than-temporarily impaired and the full amount of impairment must be charged to earnings. Otherwise, losses on securities which are other-than-temporarily impaired are separated into two categories, the portion of loss which is considered credit loss (“credit loss”) and the portion of loss which is due to other factors (“non-credit loss”). The credit loss portion is charged to earnings, 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. This guidance also expands and increases the frequency of existing disclosures about OTTI of debt and equity securities. The Company adopted the above-noted aspects of FASB ASC Topic 320 on April 1, 2009. Upon adoption, a cumulative effect adjustment, net of taxes, of $9.1 million was recorded to decrease accumulated other comprehensive income with a corresponding increase to retained earnings (accumulated deficit) for the non-credit component of previously impaired securities that the Company neither intends to sell, nor is it more likely than not that the Company will be required to sell, before recovery of amortized cost. The enhanced disclosures required by FASB ASC Topic 320 are included in Note 4 of the Company’s consolidated financial statements.
The Company adopted the provisions of FASB ASC Topic 825 which were originally issued in April 2009. The guidance requires disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies, as well as in annual financial statements, effective for interim reporting periods ending after June 15, 2009. The adoption of the above-noted aspects of FASB ASC Topic 825 in the quarter ended June 30, 2009 did not have an impact on the Company’s consolidated financial position or results of operations. The required disclosures are included in Note 5 of the Company’s 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 pro forma 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 amendments in ASU 2010-29 are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company adopted ASU 2010-29 on January 1, 2011 and will apply this guidance to future business combinations.
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 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 is assessing the impact of this adoption.
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 VIE. 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 does not expect the adoption to have a significant impact to the Company’s consolidated financial statements.
The Company has significant transactions with affiliates. Management believes inter-company revenues and expenses are calculated on a reasonable basis; however, these amounts may not necessarily be indicative of the costs that would be incurred if the Company operated on a stand-alone basis and these transactions were with unrelated parties. Below is a summary of transactions with non-consolidated affiliates which are not included in these consolidated financial statements.
On February 11, 2009, the Company received regulatory approval and entered into a reinsurance agreement with Sun Life Reinsurance (Barbados) No. 3 Corp (“BarbCo 3”) an affiliate, to cede all of the risks associated with certain in-force corporate and bank-owned variable universal life, and private placement variable universal life policies on a combination coinsurance, coinsurance with funds-withheld, and a modified coinsurance basis. The reinsurance agreement covered in-force policies on the effective date and new sales through December 31, 2009. Effective January 1, 2010, the Company and BarbCo 3 amended the reinsurance agreement. Refer to Note 8 for additional information regarding the amendment and the impact of this agreement on the Company’s consolidated financial statements.
The Company had an interest rate swap agreement with LLC with an aggregate notional amount of $900 million that effectively converts the floating rate payment obligations under the funding agreements to fixed rate obligations. This agreement expired in July 2010 due to the maturity of the floating rate funding agreements with the LLC.
Effective December 31, 2009, the Company transferred all of its employees to Sun Life Services with the exception of 28 employees who were transferred to Sun Life Financial Distributors, Inc. (“SLFD”), another affiliate. Neither Sun Life Services nor SLFD are included in the accompanying consolidated financial statements. Concurrent with this transaction, Sun Life Services assumed the sponsorship of the Company’s retirement plans, as discussed in Note 9 to the Company’s consolidated financial statements. As a result of this transaction, the Company transferred to Sun Life Services the assets and liabilities, and associated deferred tax asset, summarized in the following table:
As described in Note 9, the Company participates in a pension plan and other retirement plans sponsored by Sun Life Services.
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 assets that were sold, which was estimated to be seven years. As of December 31, 2010, the remaining deposit liability was $14.3 million.
During the years ended December 31, 2010, 2009 and 2008, the Company paid $41.4 million, $45.4 million and $23.7 million, respectively, in distribution fees to SLFD.
During the year ended December 31, 2010, the Company sold mortgage loans to SLOC with a book value of $85.6 million and a fair market value of $93.4 million and recognized a pre-tax gain of $7.8 million as a result. During the year ended December 31, 2010, the Company also purchased $52.2 million of mortgage loans from SLOC at fair value. During the year ended December 31, 2008, the Company sold mortgages to SLOC with a book value and a fair market value of $150.2 million. The Company did not purchase or sell any mortgage loan from SLOC during the year ended December 31, 2009.
In 2004, employees of the Company became participants in a restricted share unit (“RSU”) plan with the Company’s indirect parent, SLF. Under the RSU plan, participants are granted units that are equivalent to one common share of SLF stock and have a fair market value of a common share of SLF stock on the date of grant. RSUs earn dividend equivalents in the form of additional RSUs at the same rate as the dividends on common shares of SLF stock. The redemption value, upon vesting, is the fair market value of an equal number of common shares of SLF stock. The Company incurred expenses of $9.6 million, $7.9 million and $5.9 million relating to RSUs for the years ended December 31, 2010, 2009 and 2008, respectively.
At December 31, 2009, the Company determined that the VOCRA asset was impaired and recorded an impairment charge of $2.6 million included in VOCRA amortization expense. The impairment charge was allocated to the Group Protection segment.
(1) Represents the pre-tax non-credit OTTI loss recorded as a component of AOCI for assets still held at the reporting date.
ABS, RMBS and CMBS securities are shown separately in the table as they are not due at a single maturity.
Gross gains of $172.6 million, $50.0 million and $14.0 million and gross losses of $40.9 million, $57.5 million and $161.2 million were realized on the sale of fixed maturity securities for the years ended December 31, 2010, 2009 and 2008, respectively.
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, 2010 (not in thousands):
To compute the credit loss component of OTTI for corporate bonds on the date of transition (April 1, 2009), both historical default (by rating) data, used as a proxy for the probability of default, and loss given default (by issuer) projections were applied to the par amount of the bond. For corporate bonds post-transition, the present value of future cash flows using the book yield is used to determine the credit component of OTTI. If the present value of the cash flow is less than the security’s amortized cost, the difference is recorded as a credit loss. The difference between the estimates of the credit related loss and the overall OTTI is the non-credit-related component.
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:
The carrying value of mortgage loans and real estate investments, net of applicable allowances and accumulated depreciation, was as follows:
Accumulated depreciation on real estate was $45.6 million and $40.6 million at December 31, 2010 and 2009, respectively.
Included in the $1,743.1 million and $1,903.3 million of the Company’s mortgage loans in current status at December 31, 2010 and 2009, are $165.6 million and $191.4 million, respectively, of mortgage loans that are impaired but not past due.
The following table shows the gross carrying value of impaired mortgage loans and related allowances at December 31, 2010:
(1) Includes the states in which the value of the Company’s mortgage loans and real estate investments was below $50 million at December 31, 2010 and 2009, respectively.
The Company had no leveraged lease investments at December 31, 2010. The Company's net investment in the leveraged lease at December 31, 2009 was composed of the following elements:
Credit enhancement such as collateral is used to improve the credit risk of longer term derivative contracts.
As a component of its investment strategy, the Company utilizes swap agreements. Swap agreements are agreements to exchange with a counterparty a series of cash flow payments at pre-determined intervals, based upon or calculated by reference to changes in specified interest rates (fixed or floating), foreign currency exchange rates, or prices on an underlying principal balance (notional). Typically, no cash is exchanged at the outset of the contract and no principal payments are made by either party, except on certain foreign currency exchange swaps. A single net payment is usually made by one counterparty at pre-determined dates. The net payment is recorded as a component of net derivative (loss) income in the Company’s consolidated statement of operations.
Foreign currency swaps are utilized as an economic hedge against changes in foreign currencies associated with certain non-U.S. dollar denominated cash flows. From 2000 through 2002, and again in 2005, the Company marketed GICs to unrelated third parties. Each GIC transaction is highly-individualized, but typically involves the issuance of foreign currency denominated contracts backed by cross currency swaps or equity-linked cross currency swaps. The combination of the currency swaps with interest rate swaps allows the Company to lock in U.S. dollar fixed rate payments for the life of the contract.
On September 6, 2006, the Company entered into an agreement with the CARS Trust whereby the Company is the sole beneficiary of the CARS Trust. Please refer to Note 1 of the Company’s consolidated financial statements for additional information regarding the CARS Trust.
Futures contracts, both long and short, are entered into for purposes of hedging liabilities on fixed index and variable annuity products containing guaranteed minimum death benefit and living benefit features, with cash flows based on changes in equity indices. Certain futures are also utilized to hedge interest rate risk associated with these products. On the trade date, an initial cash margin is exchanged. Daily cash is exchanged to settle the daily variation margin.
In addition to short futures, the Company also utilizes over-the-counter (“OTC”) 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. Unlike futures, however, these options require initial cash outlays. The Company also purchases 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.
All realized and unrealized derivative gains and losses are recorded in net derivative loss in the Company’s consolidated statements of operations. The following is a summary of the Company’s realized and unrealized gains (losses) by derivative type for the years ended December 31:
Credit risk relates to the uncertainty of an obligor’s continued ability to make timely payments in accordance with the contractual terms of the instrument or contract. With derivative instruments, the Company is primarily exposed to credit risk through its counterparty relationships. The Company primarily manages credit risk through policies which address the quality of counterparties, contractual requirements for transacting with counterparties and collateral support agreements, and limitations on counterparty concentrations. Exposures by counterparty and counterparty credit ratings are monitored closely. All of the contracts are held with counterparties rated A or higher. As of December 31, 2010, the Company’s liability positions were linked to a total of 15 counterparties, of which the largest single unaffiliated counterparty payable net of collateral, had credit exposure of $7.9 million to the Company. As of December 31, 2010, the Company’s asset positions were linked to a total of 15 counterparties, of which the largest single unaffiliated counterparty receivable net of collateral, had credit exposure of $4.1 million.
All derivative transactions are covered under standardized contractual agreements with counterparties all of which include credit-related contingent features. Certain counterparty relationships also may include supplementary agreements with such tailored terms as additional triggers for early terminations, acceptable practices related to cross-transaction netting and minimum thresholds for determining collateral.
If counterparties are unable to meet accelerated payment obligations, the Company may also be exposed to uncollectible asset positions, offset by the value of collateral that has been posted by the Company.
At December 31, 2010, the Company pledged $224.2 million in U.S. Treasury securities as collateral to counterparties. At December 31, 2010, counterparties pledged to the Company $60.3 million in collateral comprising of cash and U.S. Treasury securities.
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 that indicate 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, 2010, there were no changes to these valuation techniques and the related inputs.
Unadjusted quoted prices for identical assets or liabilities in an active market.
(2) Excludes $501.0 million, primarily related to investment purchases payable, net of investment sales receivable, that are not subject to FASB ASC Topic 820.
The following table presents the Company’s categories for its assets measured at fair value on a nonrecurring basis as of December 31, 2009:
Structured securities, such as ABS, RMBS and CMBS, are priced using third-party pricing services, a fair value model or independent broker quotations. ABS and RMBS are priced using models and independent broker quotations. CMBS securities are priced using the last sale price of the day or a broker quote, if no sales were transacted that day. Typical inputs used by these three pricing methods include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids and/or estimated cash flows and prepayment speeds. In addition, estimates of expected future prepayments are factors in determining the price of ABS, RMBS and CMBS. These estimates are based on the underlying collateral and structure of the security, as well as prepayment speeds previously experienced in the market at interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates.
Other invested assets: This financial instrument primarily consists of equity securities. The fair value of the Company’s equity securities is first based on quoted market prices. Similar to fixed maturity securities, the Company uses pricing services and broker quotes to price the equity securities for which the quoted market price is not available.
(2) Transfers in and/or (out) of level 3 during the year ended December 30, 2010 are primarily attributable to changes in the observability of inputs used to price the securities.
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, 2009:
Transfers in and/or (out) of level 3 during the year ended December 31, 2009 are primarily attributable to changes in the observability of inputs used to price the securities.
During the year ended December 31, 2010, the Company transferred the following assets into (out of) Levels 1, 2 and 3:
The following methods and assumptions were used by the Company in determining the estimated fair value of the above financial instruments:
Debt payable to affiliates: The fair value of notes payable and other borrowings is based on future cash flows discounted at the stated interest rate, considering all appropriate terms of the related agreements. Due to certain provisions included in such agreements, whereby the issuer of the notes has the ability to call each note at par with appropriate approvals, the fair value is equal to par value.
The Company’s net investment income (loss) consisted of the following for the years ended December 31:
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 $1.5 billion at both December 31, 2010 and 2009. 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:
By reinsuring the SPWL product, the Company reduced net investment income by $49.9 million, $126.6 million and $60.3 million for the years ended December 31, 2010, 2009 and 2008, respectively. The Company also reduced interest credited by $71.5 million, $73.9 million and $74.8 million for the years ended December 31, 2010, 2009 and 2008, respectively.
On February 11, 2009, the Company received regulatory approval and entered into a reinsurance agreement with BarbCo 3, an affiliate, to cede all of the risks associated with certain in-force corporate and bank-owned variable universal life and private placement variable universal life policies on a combination coinsurance, coinsurance with funds-withheld and a modified coinsurance basis. Future new business will also be ceded under this agreement.
Effective December 31, 2007, the Company’s subsidiary, SLNY, entered into a funds-withheld reinsurance agreement with SLOC under which SLOC will fund AXXX reserves, attributable to certain universal life (“UL”) policies sold by SLNY. Under this agreement SLNY ceded, and SLOC assumed, on a funds-withheld 90% coinsurance basis certain in-force policies at December 31, 2007. Future new business will also be reinsured under this agreement. Pursuant to this agreement, SLNY held the following assets and liabilities at December 31:
Reinsurance payable includes a funds-withheld liability of $172.8 million and $128.4 million at December 31, 2010 and 2009, respectively; and a deferred gain of $52.6 million and $50.3 million at December 31, 2010 and 2009, respectively. The funds-withheld assets comprised of trading fixed maturity securities and mortgage loans are being managed by the Company. The coinsurance treaty with funds-withheld gives rise to an embedded derivative requiring that it be separated from the host reinsurance contract. The fair value of the embedded derivative increased (decreased) contractholder deposit funds and other policy liabilities by $3.2 million and $(0.7) million at December 31, 2010 and 2009, respectively.
The change in the fair value of this embedded derivative (decreased) increased derivative income by $(3.9) million, $(11.3) million, and $12.0 million for the years ended December 31, 2010, 2009 and 2008, respectively. In addition, the activities related to the reinsurance agreement have decreased revenues by $31.0 million, $29.0 million and $9.7 million, and decreased expenses by $28.0 million, $20.9 million and $11.5 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Prior to the December 31, 2009 employee transfer, the Company sponsored a postretirement benefit plan for its employees and certain affiliated employees providing certain health, dental and life insurance benefits for retired employees and dependents (the “Other Post Retirement Benefit Plan”). Expenses were allocated to participating companies based on the number of participants. Substantially all employees of the participating companies may become eligible for these benefits if they reach normal retirement age while working for the Company, or retire early upon satisfying an alternate age plus service condition. Life insurance benefits are generally set at a fixed amount.
On September 29, 2006, the FASB issued ASC Topic 715, which requires recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. The measurement date - the date at which the benefit obligation and plan assets are measured - is required to be the Company's fiscal year-end. The Company adopted the balance sheet recognition provisions of FASB ASC Topic 715 at December 31, 2006 and adopted the year end measurement date provisions effective January 1, 2008. The adoption of the year-end measurement date provisions resulted in a net of tax cumulative-effect decrease of $0.3 million to the Company’s January 1, 2008 other comprehensive income (“OCI”).
Amounts recognized in the Company’s consolidated balance sheets for the Pension Plans and the Other Post Retirement Benefit Plan consist of the following, as of December 31:
The following table sets forth the effect on retained earnings and AOCI of eliminating the early measurement date:
For the year ended December 31, 2010, Sun Life Services allocated to the Company costs of $3.1 million and $4.4 million for the Pension Plans and Other Post Retirement Benefit Plan, respectively.
Effective December 31, 2009, the Company transferred to Sun Life Services the following AOCI related to the Pension Plans and the Other Post Retirement Benefit Plan:
The asset allocation for the Company’s pension plans assets for 2008 measurement, by asset category, was as follows:
The Company contributed $6.5 million and $1.5 million to the staff pension plan and the UBF plan in 2009, respectively.
The amount of the 2009 and 2008 employer contributions under the 401(k) Plan for the Company and its affiliates was $25.2 million and $22.7 million, respectively. Amounts are allocated to affiliates based on their respective employees’ contributions. The Company’s portion of the expense was $14.2 million and $18.1 million for the years ended December 31, 2009 and 2008, respectively. For the year ended December 31, 2010, Sun Life Services allocated $17.4 million to the Company.
During the year ended December 31, 2010, no valuation allowance was recorded against the deferred tax asset for investment losses. During the year ended December 31, 2009, the Company released the cumulative recorded valuation allowance of $69.7 million that was initially established in 2008. The Company believes that it is more likely than not that the deferred tax asset related to the impairment losses will be realized due to tax planning strategies executed during the year 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.
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 net decreases in the tax liability for UTBs of $10.8 million, $8.7 million and $12.4 million in the years ended December 31, 2010, 2009 and 2008, respectively, resulted from the following:
The Company has elected to recognize interest and penalties accrued related to UTBs in interest (income) expense. During the years ended December 31, 2010, 2009 and 2008, the Company recognized $6.4 million, ($9.0) million and $3.4 million, respectively, in gross interest expense (income) related to UTBs. The Company had approximately $6.6 million and $4.8 million of interest accrued at December 31, 2010 and 2009, 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.
The Company files federal income tax returns and income tax returns in various state and local jurisdictions. With few exceptions, the Company is no longer subject to examinations by the tax authorities in these jurisdictions for tax years before 2003. In August 2006, the IRS issued a Revenue Agent’s Report for the Company’s 2001 and 2002 tax years. The Company disagreed with some of the proposed adjustments, and the case was assigned to the Appeals division of the IRS (“Appeals”). A settlement was reached and formally approved by the Company on January 11, 2010. The effects of the settlement are in line with previous expectations and had no material impact on the Company’s consolidated financial statements.
Effective December 31, 2009, the Company paid a dividend of all of the issued and outstanding common stock and net assets of Sun Life Vermont, to the Parent. Sun Life Vermont continues to be included in the consolidated federal income tax return of the Parent after 2009.
The Company regularly updates its estimates of liabilities for unpaid claims and claims adjustment expenses as new information becomes available and events occur which may impact the resolution of unsettled claims. Changes in prior estimates are recorded in results of operations in the year such changes are made. As a result of changes in estimates of insured events in prior years, the liability for unpaid claims and claims adjustment expense decreased by $1.8 million, $5.8 million and $6.6 million in 2010, 2009 and 2008, respectively.
Projected benefits and assessments used in determining the liability for contract guarantees are developed using a projection model and stochastic scenarios. Underlying assumptions for the liability related to income benefits include assumed future annuitization elections based upon factors such as eligibility conditions and the annuitant’s attained age.
Behavior Risk Margin - This component adds a margin that market participants would require for the risk that the Company’s best estimate policyholder behavior assumptions could differ from actual experience. This risk margin is determined by taking the difference between the fair value based on adverse policyholder behavior assumptions and the fair value based on best estimate policyholder behavior assumptions, using assumptions the Company believes market participants would use in developing risk margins.
Please see Note 1 of the Company’s consolidated financial statements for information regarding the deferral and amortization methodologies related to DAC and SIA. The Company tested its DAC and SIA for future recoverability and determined that the assets were not impaired at December 31, 2010.
Please see Note 1 of the Company’s consolidated financial statements for information regarding the amortization methodologies related to VOBA and VOCRA. The Company tested its VOBA and VOCRA assets for future recoverability and determined that these assets were not impaired at December 31, 2010.
The Company tested the VOCRA asset for impairment in the fourth quarter of 2009 and determined that the fair value of VOCRA 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 allocated in the Group Protection segment.
The Company’s wholly-owned subsidiary, SLNY, sells, among other products, combination fixed and variable annuity contracts (the “Contracts”) in the state of New York. These Contracts contain a fixed investment option, where interest is paid at a guaranteed rate for a specified period of time, and withdrawals made before the end of the specified period may be subject to a market value adjustment that can increase or decrease the amount of the withdrawal proceeds (the “fixed investment option period”). Effective September 27, 2007, the Company provided a full and unconditional guarantee (the “guarantee”) of SLNY’s obligation related to the Contracts’ fixed investment option period related to policies currently in-force or sold on or after September 30, 2007. The guarantee relieves SLNY of its obligation to file annual, quarterly, and current reports with the SEC on Form 10-K, Form 10-Q and Form 8-K.
In the following presentation of consolidating financial statements, the term "SLUS as Parent" is used to denote the Company as a stand-alone entity, isolated from its subsidiaries and the term “Other Subs” is used to denote the Company's other subsidiaries, with the exception of SLNY. All consolidating financial statements are presented in thousands.
(1)SLUS as Parent’s and SLNY’s net investment income includes an increase in market value of trading fixed maturity securities of $640.2 million, and $34.0 million, respectively, for the year ended December 31, 2010, related to the Company’s trading securities. Other Subs’ net investment income does not include changes in market value of trading fixed maturity securities.
(2)SLUS’, SLNY’s and Other Subs’ OTTI losses for the year ended December 31, 2009 represent impairments related to credit loss.
(2)SLUS’ and SLNY’s net derivative loss for the year ended December 31, 2008 includes $165.8 million and $0.3 million, respectively, of income related to the Company’s adoption of FASB ASC Topic 820, which is further discussed in Note 5.
(3)SLUS’ and SLNY’s amortization of DAC, VOBA, and VOCRA for year ended December 31, 2008 includes $3.0 million and $0.2 million, respectively, of expenses related to the Company’s adoption of FASB ASC Topic 820, which is further discussed in Note 5 to the Company’s consolidated financial statements.
The Corporate segment includes the unallocated capital of the Company, its debt financing and items not otherwise attributable to the other segments.
At December 31, the Company and its insurance subsidiaries’ combined statutory capital and surplus and net loss were as follows:
The Company’s and its insurance company subsidiaries’ ability to pay dividends is subject to certain statutory restrictions. The states in which the Company and its insurance company subsidiaries are domiciled have enacted laws governing the payment of dividends to stockholders by domestic insurers.
In 2010, 2009 and 2008, the Company did not pay any cash dividends to the Parent. However in 2009, 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.
Total rental expense for the years ended December 31, 2010, 2009 and 2008 was $7.2 million, $6.9 million and $8.2 million, respectively.
We have audited the accompanying consolidated balance sheets of Sun Life Assurance Company of Canada (U.S.) and subsidiaries (the "Company") as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income, stockholder’s equity, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting and reporting for other-than-temporary impairments as required by accounting guidance adopted in 2009. As discussed in Note 5 to the consolidated financial statements, the Company changed its method of accounting and reporting for the fair value measurement of certain assets and liabilities in 2008.