Omitted pursuant to Instruction I(2)(a) to Form 10-K. Please refer to Part II,
Management’s Discussion and Analysis of Financial Position and Results of Operations.
The Company’s consolidated financial statements are prepared in accordance with GAAP, which require the Company to make estimates and assumptions. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgment and complexity. Further details related to the Company’s accounting policies are described in the notes to the consolidated financial statements, which can be found in Part II, Item 8 of this annual report on Form 10-K.
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 and universal life (“UL”) are deferred and amortized with interest in proportion to the present value of 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 Company uses derivative financial instruments for risk management purposes to economically hedge against specific interest rate risk, to economically hedge guaranteed benefits in its variable products, to alter investment exposures arising from mismatches between assets and liabilities, and to minimize the Company’s exposure to fluctuations in interest rates, foreign currency exchange rates and equity market conditions. The primary types of derivatives held by the Company include interest rate and foreign currency swap agreements, swaptions, call/put options, foreign currency forwards and futures. The Company also records derivatives for certain guaranteed benefits embedded in variable and fixed indexed annuity products at fair value. The Company does not employ hedge accounting treatment. The Company believes that these derivatives provide economic hedges against the risks noted and the cost of formally documenting the effectiveness of the fair value of the hedged assets in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 815, “Derivatives and Hedging,” is not justified. As a result, the unrealized gains and losses are recognized immediately as derivative income or loss. Changes in the level of interest rates or equity markets will cause the value of these derivatives to change. Since a portion of the liabilities that are being hedged are not carried at fair value, the changes in the fair value of the derivatives will cause fluctuation in the reported earnings from period to period as foreign currency exchange rates, equity markets and interest rate change.
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 knowledgeable, unrelated willing parties at the measurement date, using inputs, including assumptions and estimates, a market participant would utilize. Due to these assumptions and estimates, the amount that may be realized in a true sale may differ significantly from the estimated fair value. 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, including third-party pricing services, independent broker quotes, and pricing models.
The following table presents the fair value of assets and liabilities, as categorized in the Company’s fair value hierarchy as of December 31, 2011 (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, 2011 (in 000’s):
With regard to the assets included in Level 3, the Company’s fixed maturity securities are made up primarily of asset-backed securities (“ABS”) including collateralized debt obligations, residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”), foreign government and agency securities and corporate securities. During the year ended December 31, 2011, the Company transferred approximately $171.7 million and $(164.7) million of assets into and (out) of Level 3. The $164.7 million of assets that were transferred out of Level 3 was primarily due to improvements in the level of observability of inputs used to price certain trading fixed maturity securities and fixed income investments. Approximately $22.3 million of the market gains included in earnings for the twelve-month period ended December 31, 2011 were primarily related to RMBS and foreign government & agency securities which were classified as held-for-trading and were measured using significant unobservable inputs. Approximately $60.8 million of the market gains included in earnings for the twelve-month period ended December 31, 2010 were primarily related to ABS, RMBS, CMBS and corporate securities which were classified as held-for-trading and were measured using significant unobservable inputs.
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 calculating 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 that the Company believes market participants would use in developing risk margins.
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, 2011 (in 000’s).
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, 2010 (in 000’s).
At December 31, 2010, $263.8 million of structured securities were classified as Level 3, representing 64.0% of the Company’s total Level 3 fixed maturity securities and 12.0% of the total structured securities at December 31, 2010.
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. In addition, 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, 2011, the Company found no material variances between the prices received from third-party pricing sources and the results of its testing.
The Company discontinues the accrual of income on its holdings for issuers that are in default. Investment income would have increased by $2.1 million and $4.6 million for the years ended December 31, 2011 and 2010, respectively, if these holdings were performing. As of December 31, 2011 and 2010, the fair market value of holdings for issuers in default was $19.6 million and $53.9 million, respectively.
Reserves held for group life and health contracts are calculated using standard actuarial methods recognized by the American Academy of Actuaries.
Contractholder deposit funds consist of policy values that accrue to the holders of UL-type contracts and investment-related products such as deferred annuities, single premium whole life (“SPWL”) policies, GICs, funding agreements and embedded derivatives related to certain annuity contracts and reinsurance 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.
The twelve-month period ended December 31, 2011 as compared to the twelve-month period ended December 31, 2010:
Premium and annuity considerations - were $137.4 million and $136.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively.
Net investment income - was $727.6 million and $1,390.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. Investment income, excluding the mark-to-market of the trading portfolio, net realized losses related to trading securities, partnership income and ceded investment income, was $607.7 million and $861.4 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The decrease of $253.7 million during 2011, as compared to 2010, was the result of lower average investment yields which decreased investment income by $134.6 million, as well as lower average invested assets which decreased investment income by $119.1 million.
The $(838.8) million increase in net derivative loss for the twelve-month period ended December 31, 2011, as compared to the same period in 2010, was primarily due to a $(1,509.4) million increase in net unrealized losses related to embedded derivatives and a $(65.7) million increase in losses related to foreign currency and equity contracts. These changes were partially offset by a $340.1 million increase in gains related to futures contracts and a $393.6 million increase in net unrealized gains related to interest rate contracts in 2011 relative to 2010.
The $(1,509.4) million increase in embedded derivatives net unrealized losses was primarily due to an increase in the fair value liability for guaranteed minimum accumulation benefits (“GMAB”) and guaranteed minimum withdrawal benefits (“GMWB”) on certain of the Company’s variable annuity products during the twelve-month period ended December 31, 2011, as compared to decrease in the fair value of the GMAB and GMWB liabilities during the same period in 2010. The increase in the liability for GMAB and GMWB during the twelve-month period ended December 31, 2011 resulted from updates to projected benefits primarily related to changes in interest rates, an increase in market volatility and assumption changes. The decrease in the GMAB and GMWB liabilities during the twelve-month period ended December 31, 2010 was primarily due to an increase in equity markets and lower market volatility during the period.
The $340.1 million increase in net derivative gains in futures contracts for the twelve-month period ended December 31, 2011 primarily related to the Company’s short exposure to the change in equity markets. Certain equity markets decreased during the year ended December 31, 2011, which resulted in an increase in net gains during the period. However, equity markets increased during the same period in 2010 resulting in losses for the twelve-month period ended December 31, 2010. The Company’s derivative instruments portfolio includes short future positions to hedge against potential adverse movements in the stock market. For discussion of the Company’s short contracts, refer to Note 4 of the Company’s consolidated financial statements presented in Part II, Item 8 of this annual report on Form 10-K.
The $393.6 million increase in net unrealized gains related to interest rate contracts for the twelve-month period ended December 31, 2011 was primarily due to changes in the fair value of interest rate swaps resulting from changes in notional amounts, duration and the overall swap curve. The increase in the fair value of interest rate swap agreements for the twelve-month period ended December 31, 2011, as compared to the twelve-month period ended December 31, 2010, was primarily the result of the downward shift in applicable interest rates.
Net realized investment gains, excluding impairment losses on available-for-sale securities - were $39.6 million and $27.0 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $39.6 million realized gains during the twelve-month period ended December 31, 2011 were primarily attributable to a $65.3 million realized gains on sales of available-for-sale fixed maturity securities, offset by a $(23.1) million loss primarily related to impairment charges on certain of the Company’s mortgage loan assets and a $(2.6) million loss due to net provisions for estimated losses on mortgage loans. 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.
Total benefits and expenses were $708.7 million and $1,708.7 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The decrease of $1.0 billion was primarily due to the following:
Interest credited - to policyholders was $424.2 million and $401.8 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The increase of $22.4 million was primarily due to an increase in capitalized interest, net of SIA amortization expense related to certain fixed annuity products, which increased interest credited by $54.8 million, and a higher average crediting rate which increased interest credited by $31.3 million. This increase was partially offset by lower average policyholder balances, which decreased interest credited by $63.7 million.
The $(1,295.3) million decrease in current period amortization expense net of interest was primarily due to a decrease in actual gross profits in 2011 relative to 2010. The decrease in actual gross profits during the twelve-month period ended December 31, 2011 primarily related to an increase in the liabilities held for guaranteed minimum benefits on certain variable annuity products, resulting in negative amortization expense. The increase in the guaranteed minimum benefit reserves was primarily attributable to the change in interest rates and assumption changes during the twelve-month period ended December 31, 2011. During the twelve-month period ended December 31, 2010, actual gross profits increased primarily due to an increase in the fair value of fixed maturity securities held in the trading portfolio which was partially offset by a smaller increase in guaranteed minimum benefit reserves, resulting in positive amortization expense.
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 $28.9 million and $33.9 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $5.0 million decrease was primarily due to a $28.1 million decrease in current year amortization, net of interest on VOBA assets for certain fixed annuity products, offset by a $23.1 million increase in unlocking adjustments during the twelve-month period ended December 31, 2011, as compared to same period in 2010.
The Company tests its VOBA and VOCRA assets for future recoverability and has determined that the asset was not impaired at December 31, 2011 and 2010.
The Wealth Management segment consists 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. Effective January 1, 2010, the Company discontinued the sale of certain of its fixed annuity products.
In 1997, the Company discontinued the marketing of group pension products in the United States. Although these products are not currently sold in the U.S., the Company administers an in-force block of U.S. group retirement business. A significant portion of these pension contracts are non-surrenderable, resulting in limited liquidity exposure to the Company.
The Wealth Management segment had pre-tax (loss) income of $(178.6) million and $246.2 million for the years ended December 31, 2011 and 2010, respectively. The significant changes are discussed below.
The $817.4 million decrease in net derivative income in 2011, as compared to 2010, primarily related to a $(1,472.9) million increase in net unrealized losses related to embedded derivatives due to an increase in the fair value of GMAB and GMWB liabilities and a $(65.7) million increase in losses related to foreign currency and equity contracts, offset by $719.2 million in gains related to futures contracts and interest rate contracts in 2011 relative to 2010. The gains in futures related to the Wealth Management segment’s short exposure to the change in equity markets in 2011, as compared to 2010. The gains in interest rate contracts were primarily due to changes in the fair value of interest rate swaps resulting from changes in notional amounts, duration and the overall swap curve.
The decrease of $711.0 million in net investment income resulted primarily from a $520.5 million decrease in the fair market value of fixed maturity securities in the Wealth Management segment’s trading portfolio in 2011, as compared to 2010. This decrease in the fair market value was primarily due 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 an approximately $1.0 billion decrease in the Wealth Management segment’s trading portfolio. The decrease in net investment income also resulted from lower average investment yields and invested assets which decreased investment income by $271.3 million in 2011, as compared to 2010. These decreases were partially offset by a $98.4 million increase in investment income related to a decrease in net investment ceded during the twelve-month period ended December 31, 2011, as compared to 2010. The net investment income ceded during twelve-month period ended December 31, 2011 includes an interest rate adjustment on certain of the Company’s SPWL policy loan balances during the period.
The decrease of $12.6 million in net realized investment gain during the twelve-month period ended December 31, 2011, as compared to the same period in 2010, was primarily due to impairment charges on certain of the Wealth Management segment’s mortgage loan assets.
The $88.8 million increase in fee and other income was primarily due to increases in mortality and expense charges, rider fees and 12b-1 fees which related to an increase in the average variable annuity separate account balances during the twelve-month period ended December 31, 2011, as compared to the twelve-month period ended December 31, 2010. The increase was also due to increased benefit fees attributable to an increase in the sales of certain variable annuity products with optional living benefit features.
The $936.0 million decrease in DAC and VOBA amortization was attributable to a $1,422.6 million decrease in amortization expense and interest. The change in amortization expense was primarily due to a decrease in actual gross profits during the twelve-month period ended December 31, 2011, as compared to the twelve-month period ended December 31, 2010. The decline in gross profits was primarily due to an increase in liabilities held for guaranteed minimum benefits on certain variable annuity products, resulting in negative amortization expense. The amortization expense and interest also includes a $99.5 million decrease related to loss recognition expense. In addition, the decrease in amortization expense was offset by a $486.6 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 the gross profit valuation for certain fixed annuity products. 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 $487.9 million decrease in DAC asset during the twelve-month period ended December 31, 2011.
The $19.6 million increase in interest credited was primarily the result of an increase in capitalized interest, net of SIA amortization expense, related to certain fixed annuity products, which increased interest credited by $54.8 million, and a higher average crediting rate, which increased interest credited by $32.8 million. These increases were offset by a lower average policyholder balances which decreased interest credited by $68.0 million. The interest credited for the twelve-month period ended December 31, 2011 includes an adjustment related to certain of the Company’s SPWL policy loan balances. The adjustment did not have any impact on interest credited, net of reinsurance, due to the 100% funds-withheld reinsurance agreement with SLOC.
The $3.1 million increase in other operating expenses was primarily due to a $9.4 million increase in non-deferrable commission expense which was attributable to an increase in sales in certain variable annuity products, offset by a decrease of $6.2 million in other operating expenses.
The Individual Protection segment consists of individual UL and variable life insurance products, including VUL, corporate-owned life insurance (“COLI”) and bank-owned life insurance (“BOLI”). 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. Effective December 30, 2011, the Company discontinued the sale of its individual life products. Effective January 31, 2012, the Company ceased issuing new COLI products. Refer to Part I, Item 1 of this annual report on Form 10-K for further details.
Total revenues were $79.0 million and $66.4 million for the years ended December 31, 2011 and 2010, respectively. The $12.6 million increase in total revenues was primarily caused by increases of $36.2 million in net investment income and $13.6 million in fees and other income, offset by decreases of $36.5 million in embedded derivative income and $0.7 million in net realized investment gains.
Total benefits and expenses were $89.4 million and $68.6 million for the years ended December 31, 2011 and 2010, respectively. The $20.8 million increase in benefits and expenses resulted from increases in other operating expenses, policyowner benefits and interest credited of $20.7 million, $5.5 million and $2.8 million, respectively, offset by a decrease in DAC amortization of $8.2 million.
The $20.7 million increase in other operating expenses resulted primarily from an $11.8 million decrease in ceded commission expense associated with certain reinsured UL and VUL products and an $8.0 million increase in premium tax and operating expenses. The $8.2 million decrease in DAC amortization was primarily due decrease in unlocking adjustments in 2011 as compared to 2010.
The Group Protection segment offers group life insurance, group stop loss insurance, group dental and group short-term and long-term disability insurance products primarily to small and mid-size employers. This segment operates only in the State of New York through the Company’s subsidiary, SLNY.
The Corporate segment consists of the unallocated capital of the Company, its debt financing and items not otherwise attributable to the other segments. The Company maintains the Corporate segment to provide for the capital needs of the three other segments and to engage in other financing related activities. Net investment income is allocated based on segmented assets, including allocated capital, by line of business. Allocations of operating expenses among segments are made using both standard rates and actual expenses incurred.
The Corporate segment had a pre-tax loss of $12.5 million and $59.3 million for the years ended December 31, 2011 and 2010, respectively. The $46.8 million decrease in pre-tax loss was attributable to an increase in total revenues of $48.6 million, offset by an increase in total benefits and expenses of $1.8 million.
The $48.6 million increase in total revenues in 2011, as compared to 2010, was primarily due to increases of $26.0 million, $15.1 million and $11.7 million in net realized investment gains, derivative income and net investment income, respectively, offset by a decrease of $5.0 million in fee and other income. The increase of $26.0 million in net realized investment gains resulted primarily from dispositions of available-for-sale fixed maturity securities. The increase of $15.1 million in derivative income related to the change in fair value of certain foreign currency contracts. The increase of $11.7 million in net investment income was primarily a result of the change in the allocation of net investment income to the operating segments and higher earnings on limited partnership investments.
Financial statements in the form required by Regulation S-X are set forth below.
The $0.1 million, $0.9 million and $4.8 million other-than-temporary impairment (“OTTI”) losses for years ended December 31, 2011, 2010 and 2009, respectively, represent solely credit losses. The Company incurred no non-credit OTTI losses during the years ended December 31, 2011, 2010 and 2009 as such, no non-credit OTTI losses were recognized in other comprehensive income for these periods.
Net of tax (expense) of $(18.0) million, $(18.6) million and $(60.1) million for the years ended December 31, 2011, 2010 and 2009, respectively.
Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”) Topic 320, “Investments-Debt and Equity Securities.”
(1) Includes $95.1 million, $(371.9) million and $(345.2) million related to settlements of derivative instruments during the years ended December 31, 2011, 2010 and 2009, respectively.
The Company and its subsidiaries offer a variety of wealth accumulation products, protection products and institutional investment contracts. These products include individual and group fixed and variable annuities, individual and group variable life insurance, individual universal life insurance, group life, group disability, group dental and group stop loss insurance and funding agreements. The Company is authorized to transact business in 49 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. In addition, the Company’s wholly-owned subsidiary, Sun Life Insurance and Annuity Company of New York (“SLNY”), is authorized to transact business in the State of New York.
On December 12, 2011, SLF announced the completion of a major strategic review of its businesses. As a result of this strategic review, SLF announced that it would close its domestic U.S. variable annuity and individual life products to new sales effective December 30, 2011. The decision to discontinue sales in these lines of business is based on unfavorable product economics which, due to ongoing shifts in capital markets and regulatory requirements, no longer enhance shareholder value. This decision reflects SLF’s intensified focus on reducing volatility and improving the return on shareholders’ equity by shifting capital to businesses with superior growth, risk and return characteristics.
Of the one-time restructuring costs on a pre-tax basis associated with the discontinuation of these products lines in the U.S., $12.7 million was allocated to the Company. The restructuring costs related primarily to employee severance and other employee benefits, which are expected to be paid in the form of future cash expenditures, as well as other costs.
During the year ended December 31, 2011, upon settlement of certain note obligations, the Company recognized $35.4 million of adjustments to contract liabilities that were not previously recorded. These adjustments should have been recorded during prior years. Prior periods have not been adjusted as the previously unrecognized amounts were not deemed to be material under Staff Accounting Bulletin (“SAB”) No. 99, “Materiality,” and SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements.”
In the normal course of business, the Company enters into transactions involving various types of financial instruments, including cash equivalents, short-term investments, fixed maturity securities, mortgage loans, equity securities, derivative financial instruments, debt, loan commitments and financial guarantees. These instruments involve credit risk and also may be subject to risk of loss due to interest rate fluctuation. The Company evaluates and monitors each financial instrument individually and, when appropriate, obtains collateral or other security to minimize losses.
The Company accounts for its investments in accordance with FASB ASC Topic 320. At the time of purchase, fixed maturity securities are classified as either trading or available-for-sale. Securities, for 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 to not sell these securities in the near term. Trading securities are carried at aggregate fair value with changes in market value reported as a component of net investment income. Securities that do not meet the trading criterion are classified as available-for-sale. Included with fixed maturity securities are forward purchase commitments on mortgage backed securities, better known as To Be Announced (“TBA”) securities. The Company records TBA purchases on the trade date and the corresponding payable is recorded as an outstanding liability in payable for investments purchased until the settlement date of the transaction. Available-for-sale securities that are not considered other-than-temporarily impaired are carried at fair value with the unrealized gains or losses reported in other comprehensive income.
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. 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 own testing.
Structured securities, typically those rated single A or below, are subject to certain provisions in FASB ASC Topic 325, “Investments-Other.” These provisions require the Company to periodically update its best estimate of cash flows over the life of the security. In the event that fair value is less than the carrying amount and there has been an adverse change in the expected cash flows, then an impairment charge, based on the difference between amortized cost and the present value of the expected cash flows discounted at the current effective rate, is recorded to income.
Policy loans are carried at the amount of outstanding principal balance. Policy loans are collateralized by the related insurance policy and do not exceed the net cash surrender value of such policy.
Estimating future gross profit is a complex process requiring considerable judgment and the forecasting of events into the future based on historical information and actuarial assumptions. These assumptions are subject to an annual review process and are updated on a more frequent basis if required. Changes in any of the assumptions that serve to increase or decrease the estimated future gross profits will cause the amortization of DAC to decrease or increase, respectively, in the current period. Assumptions affecting the computation of estimated future gross profits include, but are not limited to, recent investment and policyholder experience, expectations of future performance and policyholder behavior, changes in interest rates, capital market growth rates, and account maintenance expense.
The DAC asset under GAAP cannot exceed accumulated deferrals, plus interest. At December 31, 2009, 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 annuities was below the cap and regular amortization was recorded during the year. At December 31, 2011, the Company’s DAC asset and SIA were below the cap and regular amortization was recorded during the year.
Although recovery of DAC and the SIA 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 DAC and SIA considered recoverable could be reduced in the near term, however, if the future estimates of gross profits are reduced.
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 and VOCRA 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 affiliates, 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, 2011 and 2010, the Company recorded $49.3 million and $29.2 million, respectively, of adjustments to reserves related to loss recognition.
Policy reserves for UL contracts are held for benefit coverages that are not fully provided for in the policy account value. These include rider coverages, conversions from group policies, and benefits provided under market conduct settlements.
Contractholder deposit funds consist of policy values that accrue to the holders of UL-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.
Premiums for traditional individual life products are considered earned revenue when due. Premiums related to group life, group stop loss, group dental and group disability insurance are recognized as earned revenue pro-rata over the contract period. The unexpired portion of these premiums is recorded as unearned premiums. Revenue from UL-type products and investment-related products includes charges for the cost of insurance (mortality), initiation and administration of the policy, and surrender charges. Revenue is recognized when the charges are assessed except that any portion of an assessment that relates to services to be provided in future years is deferred and recognized over the period during which the services are provided.
The dividends-received-deduction (“DRD”) which is included in the Company’s income tax (benefit) expense, is calculated based upon the separate account assets held in connection with variable annuity contracts.
ASU 2011-02 provides guidance on whether the lender has granted a concession to the borrower and notes that:
A borrower’s inability to access funds at a market rate for a new loan with similar risk characteristics as the modified loan indicates that the modification was executed at a below-market rate and therefore may indicate that a concession was granted.
A temporary or permanent increase in the contractual interest rate as a result of restructuring does not preclude the restructuring from being considered a concession because the rate may still be below market.
In July 2010, the FASB issued 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 are included in Note 4 of the Company’s consolidated financial statements.
An embedded derivative feature relating to another type of risk (including another type of credit risk) is present in the securitized financial instrument.
The holder of an interest in a tranche of securitized financial instruments is exposed to the possibility of being required to make potential future payments because the possibility of those future payments is not created by subordination.
In February 2010, the FASB issued ASU 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, 2011 have been evaluated by the Company’s management in accordance with ASU 2010-09.
In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05,” which allows for the deferral of certain presentation requirements about reclassifications of items out of accumulated other income originally included in ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” The amendments are being made to allow FASB time to reconsider it requirements of entities to present on the face of their financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. The amendments are effective at the same time as the amendments in ASU 2011-05 so that entities will not be required to comply with the presentation requirements in ASU 2011-05 that ASU 2011-12 is deferring. All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. The amendments in ASU 2011-12 are effective for public entities for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company will adopt ASU 2011-12 on March 31, 2012 and does not expect its requirements to significantly impact the Company’s consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities,” which requires an entity to disclose information about offsetting assets and liabilities and related arrangements included in its financial statements. Offsetting (netting) assets and liabilities is an important aspect of presentation in financial statements. The differences in the offsetting requirements in GAAP and International Financial Reporting Standards (“IFRS”) account for a significant difference in the amounts presented in statements of financial position prepared in accordance with GAAP and in the amounts presented in those statements prepared in accordance with IFRS for certain institutions. This difference reduces the comparability of statements of financial position. As a result, users of financial statements requested that the differences should be addressed expeditiously. In response to those requests, the FASB and the International Accounting Standards Board are issuing joint requirements that will enhance current disclosures. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of IFRS. The amendments in ASU 2011-11 are effective, on a retrospective basis, for fiscal years and interim periods within those fiscal years beginning after December 31, 2012. The Company will adopt ASU 2011-11 on March 31, 2013 and is accessing the impact of this adoption.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income,” which revises the manner in which entities present comprehensive income in their financial statements. The amendments in ASU 2011-05 require entities to present components of comprehensive income in either a single continuous statement of comprehensive income or in two separate but consecutive statements. Under the two-statement approach, the first statement (i.e., the statement of net income) must present total net income and its components followed consecutively by the statement of comprehensive income which should include total other comprehensive income and its components. Under either method, entities must display adjustments for items that are classified from other comprehensive income to net income in both statements of net income and comprehensive income. ASU 2011-05 does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments in ASU 2011-05 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 2011-05 on March 31, 2012 and does not expect its requirements to significantly impact the Company’s consolidated financial statements.
The Company transferred all of Sun Life Vermont’s assets and liabilities at their carrying value to the Parent and therefore no gain or loss resulted from this dividend. Sun Life Vermont was previously reported as component of the Individual Protection segment.
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.
Effective December 31, 2009, the Company distributed all of Sun Life Vermont’s issued and outstanding common stock and net assets totaling $94.9 million in the form of a dividend to the Parent. The Company paid a return of capital of $300.0 million to the Parent during the year ended December 31, 2011. The Company did not declare or pay any cash dividends or return of capital to the Parent during the year ended December 31, 2010 or 2009.
On November 8, 2007, a long-term financing arrangement was established with a financial institution (the “Lender”) that enables Sun Life Vermont, a subsidiary of the Company prior to December 31, 2009, to fund a portion of its obligations under its reinsurance agreement with SLOC. Under this arrangement, at inception of the agreement, Sun Life Vermont issued an initial floating rate surplus note of $1 billion (the “Surplus Note”) to a special-purpose entity, Structured Asset Repackage Company, 2007- SUNAXXX LLC (“SUNAXXX”), affiliated with the Lender. Pursuant to this arrangement, Sun Life Vermont exercised its option to issue additional Surplus Notes of $200.0 million and $115.0 million in 2009 and 2008, respectively, to SUNAXXX. At December 31, 2009, the value of the Surplus Note was $1.3 billion. Pursuant to an agreement between the Lender and the Company’s indirect parent, Sun Life Assurance Company of Canada - U.S. Operations Holdings, Inc. (“SLC - U.S. Ops Holdings”), U.S. Ops Holdings bears the ultimate obligation to repay the Lender and, as such, consolidates SUNAXXX in accordance with FASB ASC Topic 810. Sun Life Vermont agreed to reimburse U.S. Ops Holdings for certain costs incurred in connection with the issuance of the Surplus Note. Sun Life Vermont incurred interest expense of $21.7 million for the year ended December 31, 2009, which is included in the Company’s consolidated statements of operations as a component of income from discontinued operations, net of tax.
At December 31, 2011 and 2010, the Company had an $18.0 million promissory note that was initially issued to Sun Life (Hungary) Group Financing Limited Company (“Sun Life (Hungary) LLC”), an affiliate, for which the Company pays interest semi-annually. On June 2, 2011, Sun Life (Hungary) LLC sold the $18.0 of promissory note to SLOC. With the exception of the change in lenders, this transaction did not have any impact on the terms of the promissory note. Effective June 2, 2011, the Company began paying the related interest to SLOC. Related to this note, the Company incurred interest expense of $1.0 million for each of the years ended December 31, 2011, 2010 and 2009.
The Company has an interest rate swap agreement with LLC III with an aggregate notional amount of $900.0 million that effectively converts the floating rate payment obligations under the funding agreements to fixed rate obligations.
On June 3, 2005 and June 29, 2005, the Company issued two floating rate funding agreements totaling $900 million to Sun Life Financial Global Funding, L.L.C. (“LLC”), an affiliate. On April 7, 2008, the Company issued an additional floating rate funding agreement totaling $10 million to LLC. On July 1 and July 8, 2010, the Company paid $900.0 million and $10.0 million, respectively, to the LLC due to the maturity of these funding agreements. Total interest credited for these funding agreements was $2.9 million and $11.3 million for the years ended December 31, 2010 and 2009, respectively. On August 6, 2010, the Company paid $100.1 million to LLC, including $0.1 million in interest due to settle a $100.0 million floating rate demand note payable. The Company expensed $0.5 million and $1.3 million for the years ended December 31, 2010 and 2009, respectively, for interest on this demand note.
The Company had an interest rate swap agreement with LLC with an aggregate notional amount of $900.0 million that effectively converts the floating rate payment obligations under the funding agreements to fixed rate obligations. The related $900.0 million interest rate swap agreement expired on July 6, 2010 due to the maturity of the underlying floating rate funding agreements with LLC.
The following table lists the details of notes due to affiliates at December 31, 2010:
Pursuant to an administrative services agreement between the Company and Sun Life Services which was effective December 31, 2009, Sun Life Services provides human resources services (e.g., recruiting and maintaining appropriately trained and qualified personnel and equipment necessary for the performance of actuarial, financial, legal, administrative and other operational support functions) to the Company. The Company reimburses Sun Life Services for the cost of such services, plus, with respect to certain of those services, pays an arms-length based profit margin to be agreed upon by the parties. Total payments under this agreement were $110.0 million and $117.6 million for the years ended December 31, 2011 and 2010, respectively.
As discussed in Note 1, SLF made the decision to close its domestic U.S. variable annuity and individual life products to new sales after completing a major strategic review of its businesses. As a result of this decision and the related severance of certain Sun Life Services’ employees, Sun Life Services allocated $12.2 million in expenses to the Company, which is a portion of the related restructuring costs on a pre-tax basis. The costs allocated to the Company represent primarily employee severance and other employee benefits of $10.2 million, as well as other costs of $2.0 million.
Effective December 31, 2009, Sun Life Services and SLOC entered into an administrative services agreement under which Sun Life Services provides to SLOC, as requested, personnel and certain services. Prior to December 31, 2009, the Company had an administrative services agreement with SLOC under which the Company provided personnel and certain services to SLOC, as requested. Pursuant to the agreement with SLOC, the Company recorded reimbursements of $336.0 million for the year ended December 31, 2009, as a reduction to other operating expenses. Effective December 31, 2009, the Company no longer provides personnel services to SLOC and SLOC no longer reimburses the Company for such services.
The Company continues to provide certain services to SLOC under an administrative services agreement. Pursuant to this agreement, the Company recorded reimbursements of $99.3 million and $99.1 million for the years ended December 31, 2011 and 2010, respectively.
The Company has an administrative services agreement with Sun Life Information Services Canada, Inc. (“SLISC”), under which SLISC provides administrative and support services to the Company in connection with the Company’s insurance and annuity businesses. Expenses under this agreement amounted to approximately $19.3 million, $18.0 million and $15.5 million for the years ended December 31, 2011, 2010 and 2009, respectively. In addition, SLISC allocated $0.1 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 SLC - U.S. Ops Holdings, under which the Company provides administrative and investor services with respect to certain open-end management investment companies for which an affiliate, Massachusetts Financial Services Company (“MFS”), serves as the investment adviser, and which are offered to certain of the Company’s separate accounts established in connection with the variable annuity contracts issued by the Company. Amounts received under this agreement were approximately $12.7 million, $13.0 million and $8.9 million for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company leases office space to SLOC under lease agreements with terms expiring on December 31, 2014 and options to extend the terms for each of twelve successive five-year terms at fair market rental value, not to exceed 125% of the fixed rent for the term which is then ending. Rent received by the Company under the leases amounted to approximately $12.1 million, $12.1 million and $10.1 million for the years ended December 31, 2011, 2010 and 2009, respectively. Rental income is reported as a component of net investment income on the Company’s consolidated statements of operations.
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. The Company did not purchase or sell any mortgage loans from SLOC during the years ended December 31, 2011 and 2009.
At December 31, 2009, the Company determined that the VOCRA asset was impaired and recorded an impairment charge of $2.6 million which is included in VOCRA amortization expense. The impairment charge was allocated to the Group Protection segment.
The Company settles with its affiliates payments related to the administrative service agreements, rent and other on a monthly basis. At December 31, 2011 and 2010, the Company’s net receivable due from affiliated companies was $21.4 million and $32.5 million, respectively.
The amortized cost and estimated fair value by maturity periods for fixed maturity securities held at December 31, 2011 are shown below. Actual maturities may differ from contractual maturities on structured securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Gross gains of $119.3 million, $172.6 million and $50.0 million and gross losses of $51.3 million, $40.9 million and $57.5 million were realized on fixed maturity securities for the years ended December 31, 2011, 2010 and 2009, respectively.
As of December 31, 2011 and 2010, 92.3% and 92.4%, respectively, of the Company's fixed maturity securities were investment grade. Investment grade securities are those that are rated "BBB" or better by a nationally recognized statistical rating organization. Securities that are not rated by a nationally recognized statistical rating organization are assigned ratings based on the Company's internally prepared credit evaluations.
Beginning on April 1, 2009, the Company presents and discloses OTTI in accordance with FASB ASC Topic 320. Securities whose fair value is less than their carrying amount are considered to be impaired and are evaluated for potential OTTI. 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 considered other-than-temporarily impaired and the Company records a charge to earnings for the full amount of impairment based on the difference between the amortized cost and fair value of the security. 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 an available-for-sale fixed maturity is considered temporary, the Company continues to record the unrealized loss in other comprehensive income and not in earnings.
As a result of the adoption of FASB ASC Topic 320, a cumulative effect adjustment, net of tax, 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 loss 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.
Discrete credit events, such as a ratings downgrade, also are used to identify securities that may be other-than-temporarily impaired. The securities identified are then evaluated based on issuer-specific facts and circumstances, such as the issuer’s ability to meet current and future interest and principal payments, an evaluation of the issuer’s financial position and its near-term recovery prospects, difficulties being experienced by an issuer’s parent or affiliate, and management’s assessment of the outlook for the issuer’s sector. In making these evaluations, the Credit Committee exercises considerable judgment. Based on this evaluation, issues or issuers are considered for inclusion on one of the Company’s following credit lists:
“Watch List”- Management has concluded that the Company’s amortized cost will be recovered through timely collection of all contractually specified cash flows, but that changes in issuer-specific facts and circumstances require continued monitoring during the quarter. A security is moved from the Monitor List to the Watch List when changes in issuer-specific facts and circumstances increase the possibility that a security may become impaired within the next 24 months. No OTTI charge is recorded in the Company’s consolidated statements of operations for unrealized losses on securities related to these issuers.
There are inherent risks and uncertainties in management’s evaluation of securities for OTTI. These risks and uncertainties include factors both external and internal to the Company, such as general economic conditions, an issuer’s financial condition or near-term recovery prospects, market interest rates, unforeseen events which affect one or more issuers or industry sectors, and portfolio management parameters, including asset mix, interest rate risk, portfolio diversification, duration matching and greater than expected liquidity needs. All of these factors could impact management’s evaluation of securities for OTTI.
For securities that are assessed to have incurred a credit loss, the amount of credit loss is calculated based upon the cash flows that the Company expects to collect given an assessment of the relevant facts and circumstances for the issuer and specific bond issue. Such factors include the financial condition, credit quality, and the near-term prospects of the issuer, as well as the issuer's relative liquidity, among other factors.
The Company performs ongoing qualitative assessments of its VIEs under FASB ASC Topic 810, to determine whether it has a controlling financial interest in the VIE and, therefore, is the primary beneficiary. The Company is deemed to have a controlling financial interest 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. The Company consolidates the VIE in its consolidated financial statements if it determines that it is the VIEs primary beneficiary.
At December 31, 2011, the Company had an interest in one significant VIE, Credit and Repackaged Securities Limited Series 2006-10 Trust (the “CARS Trust”), for which consolidation is required under FASB ASC Topic 810.
The CARS Trust is a structured investment vehicle for which the Company provides investment management services and holds securities issued by the trust. Creditors have no recourse against the Company in the event of default by the CARS Trust, nor does the Company have any implied or unfunded commitments to the CARS Trust. The Company's financial or other support provided to the CARS Trust is limited to its investment management services and original investment. The following table presents the carrying value of assets and liabilities and the maximum exposure to loss relating to the CARS Trust.
At December 31, 2011, other than the CARS Trust, the Company had no interest in VIEs for which consolidation is required under FASB ASC Topic 810.
The carrying value of the Company’s mortgage loans and real estate investments, net of applicable allowances and accumulated depreciation, was as follows:
A 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. The allowance for credit losses is 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 loan collateral, less cost to sell, is less than the recorded amount of the loan. 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 allowances, future adjustments may become necessary if economic conditions differ from the assumptions used in calculating them.
The Company’s allowance for mortgage loan losses at December 31 was as follow:
The activity in the allowance for loan loss was as follows:
The Company may modify the terms of a loan by adjusting the interest rate, extending the maturity date or both. The Company evaluates each restructuring of debt and considers it a TDR if, for economic or legal reasons related to the debtor's financial difficulties, it grants a concession to the borrower that it would not otherwise consider. Specifically, the Company's evaluation of each restructuring includes an assessment of the indicators of impairment to determine if the debtor is exhibiting financial difficulties and an assessment of market lending activity to determine if the debtor can obtain funds from other sources at market interest rates at or near those for nontroubled debts. Those restructurings where financial difficulties are present and alternative sources of funding are not available or prohibitively expensive to the borrower are considered TDR.
All TDRs identified by the Company are commercial mortgage loans modified by granting concessions to borrowers where, as a result of the restructuring, the Company does not expect to collect all amounts due, including interest accrued at the original contract rate.
(1) Represents the number of contracts that were modified and considered as TDR. The number of contracts is not in thousands.
Defaults are factored into the determination of the allowance for credit losses by indicating that, as a result of the default, the Company does not expect to collect all amounts due per the modified terms. The following table shows the number and value of TDRs within the previous twelve months for which there was a payment default during the year ended (the number of contracts is not in thousands):
(1) Includes the states in which the value of the Company’s mortgage loans and real estate investments was below $50.0 million at December 31, 2011 and 2010, respectively.
The Company was an owner participant in a trust that is a lessor in a leveraged lease agreement entered into on October 21, 1994, under which equipment having an estimated economic life of 25-40 years was originally leased through a VIE for a term of 9.78 years. The master lessee had the option to purchase the equipment at the expiration of the lease term. The Company's equity investment in this VIE represented 8.33% of the partnership that provided 22.9% of the purchase price of the equipment. The Company did not have the ability to direct the activities that most significantly impact the economic performance of the VIE, nor did it have the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. Therefore, the Company did not consolidate this trust in its consolidated financial statements. The balance of the purchase price was furnished by third-party long-term debt financing, collateralized by the equipment, and was non-recourse to the Company. The leveraged lease investment was included as a part of other invested assets in the Company’s consolidated balance sheet at December 31, 2009.
The Company uses derivative financial instruments for risk management purposes to hedge against specific risks related to interest rates, foreign currency exchange rates, and equity market conditions, as well as to alter exposure arising from mismatches between assets and liabilities. Derivative instruments are recorded in the consolidated balance sheets at fair value and are presented as assets or liabilities.
The primary types of derivatives held by the Company include interest rate and foreign currency swap agreements, swaptions, futures, listed and over-the counter (“OTC”) equity options, foreign currency forwards and embedded derivatives, as described below.
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) or foreign currency exchange rates. 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 in the Company’s consolidated statement of operations.
Interest rate swaps are generally used to manage the sensitivity of the duration gap between assets and liabilities to interest rate changes or to manage the exposure to product guarantees sensitive to movements in equity market and interest rate levels related to life insurance contracts, fixed index annuities and variable annuities.
The Company utilizes payer swaptions to hedge exposure to interest rate risk, typically on product guarantees. Swaptions give the buyer the option to enter into an interest rate swap per the terms of the original swaption agreement. A premium is paid on settlement date and no further cash transactions occur until the positions settle or expire. At expiration, the swaption either cash settles for value, settles into an interest rate swap, or expires worthless per the terms of the original swaption agreement. At December 31, 2011, the Company did not have any position in swaptions.
Equity, interest rate and foreign exchange 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 guaranteed minimum living benefit features, with cash flows based on changes in equity indices, interest rates or foreign exchange rates. On the trade date, an initial cash margin is deposited as required by the relevant stock exchange. Cash is subsequently exchanged daily to settle the variation margin or daily fluctuations in the underlying index.
A foreign currency forward is an agreement between two parties to buy and sell currencies at the current market rate, for settlement at a specified future date. Foreign currency forwards are utilized as an economic hedge against changes in foreign currencies associated with certain non-U.S. dollar denominated cash flows.
With the exception of embedded derivatives, all derivatives are carried at fair value in derivative instruments - receivable or derivative instruments - payable in the Company’s consolidated balance sheets. Embedded derivatives related to reinsurance agreements and annuity contracts are carried at fair value in contractholder deposit funds and other policy liabilities in the Company’s consolidated balance sheets. The following is a summary of the Company’s derivative asset and liability positions by primary risk exposure.
Embedded derivatives expose the Company to a combination of credit, interest rate and equity price risks.
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, 2011, the Company’s liability positions were linked to a total of 5 affiliated and unaffiliated counterparties, of which the largest single unaffiliated counterparty payable, net of collateral, had credit exposure of $17.7 million to the Company. As of December 31, 2011, the Company’s asset positions were linked to a total of 11 affiliated and unaffiliated counterparties, of which the largest single unaffiliated counterparty receivable, net of collateral, had credit exposure of $3.9 million.
Certain counterparty relationships also may include supplementary agreements with additional triggers related to credit downgrades of the Company or its counterparty. If the Company’s credit rating were to fall below the stipulated level, this could result in a reduction of minimum thresholds in collateral agreements or full overnight collateralization. These impacts can frequently be mitigated, however, through re-negotiation of contractual terms.
At December 31, 2011, the Company pledged $289.6 million in U.S. Treasury securities as collateral to counterparties. At December 31, 2011, counterparties pledged to the Company $245.1 million in collateral comprised of cash and U.S. Treasury securities.
The Company has categorized its financial instruments that are carried at fair value into a three-level hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.
Quoted prices in markets that are not active or significant inputs that are observable either directly or indirectly.
The types of assets and liabilities utilizing Level 2 valuations generally include U.S. Government securities not backed by the full faith and credit of the Government, municipal bonds, structured notes and certain ABS including collateralized debt obligations, RMBS, CMBS, certain corporate debt, certain private equity investments and certain derivatives, including derivatives embedded in reinsurance contracts.
Prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. They reflect management's assumptions about what a market participant would use in pricing the asset or liability.
Generally, the types of assets and liabilities utilizing Level 3 valuations are certain ABS, RMBS and CMBS, certain corporate debt, certain private equity investments, certain mutual fund holdings and certain derivatives, including certain derivatives embedded in reinsurance and annuity contracts and certain funding agreements.
The following table presents the Company’s categories for its assets measured at fair value on a recurring basis as of December 31, 2011:
(2) Pursuant to the conditions set forth in FASB ASC Topic 944, the value of separate account liabilities is set to equal the fair value of the separate account assets.
The following table presents the Company’s categories for its liabilities measured at fair value on a recurring basis as of December 31, 2011:
(2) Bank overdrafts are included within other liabilities in the Company’s consolidated balance sheet.
The following table presents the Company’s categories for its assets measured at fair value on a recurring basis as of December 31, 2010:
Pursuant to the conditions set forth in FASB ASC Topic 944, the value of separate account liabilities is set to equal the fair value of the separate account assets.
The following table presents the Company’s categories for its liabilities measured at fair value on a recurring basis as of December 31, 2010:
Structured securities, such as ABS, RMBS and CMBS, are priced using third-party pricing services, a fair value model or 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 estimated using models which 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 Company’s ability to liquidate positions in privately-placed fixed securities and mortgages 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.
(1) The realized/unrealized gains and 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.
Mortgage loans: The fair values of mortgage loans 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.
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 most of the notes has the ability to call the notes at par with appropriate approvals, the fair value is equal to par value. The note, whose issuer does not have the ability to call at par, is reported at fair value.
Ceded investment income on funds-withheld reinsurance portfolios is included as a component of net investment income and is accounted for consistent with the policies discussed in Note 1 of the Company’s consolidated financial statements. Net investment income ceded and interest earned on policy loans during the year ended December 31, 2011 were decreased by a $113.3 million prior-year adjustment related to the interest rate on policy loans. Refer to the Wealth Management section in Note 8 to the Company’s consolidated financial statements for further discussion of this adjustment. The ceded investment income relates to the funds-withheld reinsurance agreements between the Company and certain affiliates, which is further discussed in Note 8 to the Company’s consolidated financial statements.
Reinsurance ceded contracts do not relieve the Company from its obligations to its policyholders. The Company remains liable to its policyholders for the portion reinsured to the extent that any reinsurer does not meet the obligations assumed under the reinsurance agreement. To minimize its exposure to significant losses from reinsurer insolvencies, the Company regularly evaluates the financial condition of its reinsurers and monitors concentrations of credit risk. Management believes that any liability from this contingency is unlikely.
(1) Investment income earned (direct) and ceded during the year ended December 31, 2011 includes a decrease of $113.3 million due to an interest rate adjustment. This adjustment did not have any impact on net investment income. Refer to the Wealth
(2) Interest credited ceded during the year ended December 31, 2011 includes a $113.3 million interest rate adjustment decreasing ceded interest credited. Refer to the Wealth Management section of this Note 8 for further details.
The funds-withheld assets of $1.4 billion and $1.6 billion at December 31, 2011 and 2010, respectively, are comprised of fixed maturity securities, mortgage loans, policy loans, derivative instruments, and cash and cash equivalents that are managed by the Company. The fair value of the embedded derivative increased contractholder deposit funds and other policy liabilities by $31.8 million and $14.0 million at December 31, 2011 and 2010, respectively. The change in the fair value of this embedded derivative decreased derivative income by $17.8 million, $24.6 million, and $120.0 million for the years ended December 31, 2011, 2010 and 2009, 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.
The change in fair value of the embedded derivative (decreased) increased derivative income by $(10.0) million and $2.2 million for the years ended December 31, 2011 and 2010, respectively. In addition, during the years ended December 31, 2011 and 2010, the reinsurance agreement reduced revenues by $53.2 million and $24.3 million, respectively, and decreased expenses by $31.3 million and $56.2 million, respectively.
The Company’s subsidiary, SLNY, has a funds-withheld reinsurance agreement with SLOC under which SLOC funds a portion of the statutory reserves (“AXXX reserves”) required by New York Regulation 147, which is substantially similar to Actuarial Guideline 38, as adopted by the NAIC, attributable to certain 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. Pursuant to this agreement, SLNY held the following assets and liabilities at December 31:
Reinsurance payable includes a funds-withheld liability of $194.3 million and $172.8 million at December 31, 2011 and 2010, respectively, and a deferred gain of $43.7 million and $52.6 million at December 31, 2011 and 2010, respectively. The funds-withheld assets are managed by the Company and are comprised of trading fixed maturity securities, policy loans, equity securities, mortgage loans and related accrued income, totaling $191.2 million and $176.7 million at December 31, 2011 and 2010, respectively. The coinsurance agreement with funds-withheld gives rise to an embedded derivative which is required to be separated from the host reinsurance contract. The fair value of the embedded derivative increased contractholder deposit funds and other policy liabilities by $31.2 million and $3.2 million at December 31, 2011 and 2010, respectively.
The change in the fair value of this embedded derivative decreased derivative income by $28.1 million, $3.9 million and $11.3 million for the years ended December 31, 2011, 2010 and 2009, respectively. In addition, the activities related to the reinsurance agreement have decreased revenues by $48.8 million, $31.0 million and $29.0 million, and decreased expenses by $26.8 million, $28.0 million and $20.9 million for the years ended December 31, 2011, 2010 and 2009, respectively.
The Company has other reinsurance agreements with SLOC and several unrelated companies, which provide reinsurance for portions of the net-amount-at-risk under certain individual variable universal life, individual private placement variable universal life, bank owned life insurance (“BOLI”) and corporate owned life insurance (“COLI”) policies. These amounts are reinsured on a monthly renewable term, a yearly renewable term or a modified coinsurance basis. These other agreements decreased revenues by approximately $91.7 million, $134.7 million and $173.9 million and reduced expenses by approximately $79.9 million, $140.1 million and $168.5 million for the years ended December 31, 2011, 2010 and 2009, respectively.
SLNY has several agreements with unrelated companies whereby the unrelated companies reinsure the mortality and morbidity risks of certain of SLNY’s group contracts.
Effective December 31, 2009, the Company transferred all of its employees to an affiliate, Sun Life Services, with the exception of 28 employees who were transferred to SLFD, another affiliate. As a result of this transaction, the Company transferred pension and other employee benefit liabilities, accumulated other comprehensive income related to pension and other postretirement plans, and cash to Sun Life Services. Concurrent with this transaction, Sun Life Services became the sponsor of the retirement plans described below. The employee transfer did not materially change the provisions of the related retirement plans. The annual cost of these benefits to the Company is allocated and charged to the Company in a manner consistent with the allocation of employee compensation expenses.
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.
The following tables set forth the change in the Pension Plans’ and the Other Post-Retirement Benefit Plan’s projected benefit obligations and assets, as well as information on the plans’ funded status at December 31, 2009:
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:
Weighted average assumptions used to determine benefit obligations for the Pension Plans and the Other Post-Retirement Benefit Plan were as follows:
Weighted average assumptions used to determine net (benefit) cost for the Pension Plans and the Other Post-Retirement Benefit Plan were as follows:
Federal income taxes attributable to the Company’s consolidated operations are different from the amounts determined by multiplying income before federal income taxes by the expected federal income tax rate of 35%. The following is a summary of the differences between the expected income tax (benefit) expense at the prescribed U.S. federal statutory income tax rate and the total amount of income tax (benefit) expense that the Company has recorded.
The liability for unrecognized tax benefits (“UTBs”) related to permanent and temporary tax adjustments, exclusive of interest, was $32.9 million, $31.2 million and $42.0 million at December 31, 2011, 2010 and 2009, respectively. Of the $32.9 million, $1.6 million represents the amount of UTBs that, if recognized, would favorably affect the Company’s effective income tax rate in future periods, exclusive of any related interest.
The net increase (decreases) in the tax liability for UTBs of $1.7 million, $(10.8) million and $(8.7) million in the years ended December 31, 2011, 2010 and 2009, respectively, resulted from the following:
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, filed a protest, 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.
The Company will file a consolidated federal income tax return with SLC - U.S. Ops Holdings for the year ended December 31, 2011, as the Company did for the years ended December 31, 2010 and 2009.
Effective December 31, 2009, the Company paid a dividend of all of the issued and outstanding common stock 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 expenses increased (decreased) by $0.5 million, $(1.8) million and $(5.8) million, during the years ended December 31, 2011, 2010 and 2009, respectively.
The liability for death and income benefit guarantees is established equal to a benefit ratio, multiplied by the cumulative contract charges earned, plus accrued interest less contract benefit payments. The benefit ratio is calculated as the estimated present value of all expected contract benefits divided by the present value of all expected contract charges. The benefit ratio may be in excess of 100%. For guarantees in the event of death, benefits represent the current guaranteed minimum death payments in excess of the current account balance. For guarantees at annuitization, benefits represent the present value of the minimum guaranteed annuity benefits in excess of the current account balance.
The liability for guarantees is re-calculated and adjusted regularly. Changes to the liability balance are recorded as a charge or credit to policyowner benefits.
The following roll-forward summarizes the change in DAC asset and SIA for the years ended December 31:
Refer to Note 1 of the Company’s consolidated financial statements for information regarding the deferral and amortization methodologies related to DAC asset and SIA. The Company tested its DAC asset and SIA for future recoverability and determined that the assets were not impaired at December 31, 2011.
During the year ended December 31, 2011, the Company recorded a negative amortization increasing its DAC asset and SIA by $770.2 million. The negative amortization related to a decrease in actual gross profit which was due to a $1.3 billion increase in the fair value of GMAB and GMWB liabilities related to certain variable annuity products. The increase in DAC asset and SIA was offset by an unlocking adjustment decreasing DAC asset and SIA by $575.2 million. The unlocking adjustment recorded in 2011 was due to the total present value of the gross profit for the largest cohort of the Company’s fixed annuities, which was negative at December 31, 2011 resulting in decrease in DAC asset and SIA.
The Company wrote down DAC asset and SIA by $21.0 million and $126.0 million as a result of loss recognition related to certain annuity products for the years ended December 31, 2011 and 2010, respectively. Of the $21.0 million charge for loss recognition in 2011, $18.3 million related to DAC and was reported as amortization of DAC. The remaining $2.7 million related to SIA and was reported as a component of interest credited in the Company’s consolidated statement of operations. Of the $126.0 million charge for loss recognition in 2010, $117.7 million related to DAC and was reported as amortization of DAC. The remaining $8.3 million related to SIA and was reported as a component of interest credited in the Company’s consolidated statement of operations.
Refer to 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 the assets were not impaired at December 31, 2011.
The products of the Company’s wholly-owned subsidiary, SLNY, include, 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 fixed investment option period related to Contracts currently in-force or sold on or after that date. The guarantee relieved 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 standalone 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.
SLUS as Parent’s and SLNY’s OTTI losses for the year ended December 31, 2011 represent impairments related to credit loss.
SLUS as Parent’s and SLNY’s net investment income includes an increase in market value of trading investments of $640.2 million, and $34.0 million, respectively, for the year ended December 31, 2010. Other Subs’ net investment income does not include trading investments.
SLUS as Parent’s, SLNY’s and Other Subs’ OTTI losses for the year ended December 31, 2009 represent impairments related to credit loss.
Pursuant to Delaware's statute, the maximum amount of dividends and other distributions that a domestic insurer may pay in any twelve-month period without prior approval of the Delaware Commissioner of Insurance is limited to the greater of (i) ten percent of its statutory surplus as of the preceding December 31, or (ii) the individual company's statutory net gain from operations for the preceding calendar year. Any dividends to be paid by an insurer from a source other than statutory surplus, whether or not in excess of the aforementioned threshold, would also require the prior approval of the Delaware Commissioner of Insurance. The Company is not permitted to pay dividends in 2012 without prior approval from the Delaware Commissioner of Insurance.
In Revenue Ruling 2007-61, issued on September 25, 2007, the IRS announced its intention to issue regulations with respect to certain computational aspects of the dividends-received-deduction (the “DRD”) on separate account assets held in connection with variable annuity contracts. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54, issued on August 16, 2007, that purported to change accepted industry and IRS interpretations of the statutes governing computational questions impacting the DRD. On May 30, 2010, the IRS issued an Industry Director Directive which makes clear that IRS interpretations prior to Revenue Ruling 2007-54 should be followed until new regulations are issued. New DRD regulations that the IRS proposes for issuance on this matter will be subject to public comment, at which time the insurance industry and other interested parties will have the opportunity to raise comments and questions about the content, scope and application of new regulations. The timing, substance and effective date of the new regulations are unknown, but they could result in the elimination of some or all of the separate account DRD tax benefit that the Company ultimately receives. For the years ended December 31, 2011 and 2010, the Company recorded benefits of $14.8 million and $11.5 million, respectively, related to the separate account DRD. The amounts recorded for the year ended December 31, 2010 included an adjustment of $3.2 million to reflect a reduced run rate of separate account DRD benefits following the filing of the 2009 tax return.
The Company leases certain facilities under operating leases with terms of up to five years. As of December 31, 2011, minimum future lease payments under such leases were as follow:
Total rental expense for the years ended December 31, 2011, 2010 and 2009 was $7.0 million, $7.2 million and $6.9 million, respectively.
We have audited the accompanying consolidated balance sheets of Sun Life Financial Assurance Company of Canada (U.S.) and subsidiaries (the "Company") as of December 31, 2011 and 2010, 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, 2011. 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.