On December 31, 2002, the operations SLNY were merged with KBL. As a result of this merger Keyport, an affiliate of the Company, owns 67% of the combined entity and the Company retained a 33% interest in the combined entity.
For the year ended December 31, 2002, the results of operations for SLNY have been consolidated with the Company's results. As of December 31, 2002, the assets and liabilities of SLNY are no longer consolidated with the Company's.
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. This will cause fluctuation in earnings from period to period. During 2002, DAC amortization was increased by $96.0 million due to actual results and revised estimates of future gross profits. The change in the market value of separate accounts assets (approximately $57.0 million) and revised cash flow assumptions (approximately $39.0 million) were the major items affecting the change in gross profit assumptions.
Certain of the fixed maturities are classified as trading and others as available-for-sale. The changes in fair value of trading securities are recorded as a component of net investment income. The changes in fair value of available-for-sale securities are recorded in other comprehensive income.
The Company's ability to liquidate positions in privately placed fixed securities and mortgages will 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, key assumptions about the risk-free interest rates, risk premiums, performance of underlying collateral (if any) and other factors may not reflect those of an active market.
The liabilities associated with traditional life insurance (individual life, group life and group disability insurance products) are computed using the net level premium method based on assumptions about future investment yields, mortality, morbidity and persistency. The assumptions used are based upon the Company's experience and industry standards.
Once these assumptions are made for a given group of policies they will not be changed over the life of the policies unless the Company recognizes a loss on the entire line of business. The Company periodically reviews its policies for loss recognition based upon management's best estimates. From time to time the Company may recognize a loss on certain lines of business. During 2002, the mortality assumptions related to the single premium pension contracts were adjusted to reflect expected payment and as a result a loss of $38 million was recognized on the Company's group pension line of business.
The Company's net income from operations reflects the operations of its four business segments: Wealth Management, Individual Protection, Group Protection and Corporate. Prior years segmented results have been restated to include the results of the Company's investment advisor subsidiary, SCA, with the Wealth Management segment instead of the Corporate segment.
The Wealth Management segment focuses on the savings and retirement needs of individuals preparing for retirement or who have already retired and, through the second quarter of 2002, marketed guaranteed investment contracts (''GICs'') to unrelated third parties in overseas markets. In the United States, the segment primarily markets to affluent consumers, selling individual and group fixed and variable annuities. Its major product lines, ''Regatta'' and ''Futurity,'' are combination fixed/variable annuities. In these combination annuities, contractholders have the choice of allocating payments either to a fixed account, which provides a guaranteed rate of return, or to variable accounts. Withdrawals from the fixed account are subject to market value adjustment. In the variable accounts, the contractholder can choose from a range of investment options and styles. The return depends upon investment performance of the options selected. Investment funds available under Regatta products are managed by MFS, an affiliate of the Company. Investment funds available under Futurity and Regatta Masters products are managed by several investment managers, including MFS and SCA, a subsidiary of the Company.
The Company sells its annuity products via two affiliated wholesale distribution organizations, MFS Fund Distributors, Inc. (Regatta and Regatta Masters products) and MFSLF (Futurity products). The annuity products are then distributed through a variety of unaffiliated retail organizations including securities brokers, financial institutions, insurance agents, and financial advisers.
In 1997, the Company decided to discontinue the marketing of group pension and GIC products in the U.S. Although these pension products are not currently sold in the U.S., there continues to be a block of U.S. group retirement business in-force, including GICs, pension plans and group annuities. A significant portion of these pension contracts is non-surrenderable, resulting in limited liquidity exposure to the Company. GICs were marketed directly in the U.S. through independent managers. From the second quarter of 2000 until the second quarter of 2002, when the Company withdrew from this line of business, the Company marketed GICs to unrelated third parties in overseas markets.
The following is a summary of operations for the Wealth Management Segment for the years ended December 31:
Fee income was $283 million and $260 million for the years ended December 31, 2002 and 2001, respectively. The increase of $23 million is primarily the result of increased fee income earned on service contracts between the Company's subsidiaries and affiliates outside of the consolidated group, offset by decreased mortality and expense fees. In 2002 the Company's distribution fees increased $24 million, administration and service fees increased $15 million, and the Company's investment advisor subsidiary's fees increased $10 million. These increases were primarily due to new service agreements entered into at the end of 2001. Offsetting the increased fees were decreased mortality and expense fees of $32 million in 2002. Mortality and expense fees are based on the average net assets of variable annuity accounts. Variable annuity assets have decreased by approximately $2.4 billion since December 31, 2001 due to market depreciation and lower net deposits. Deposits to annuity products decreased by $1.1 billion compared to 2001.
Deposits in the Futurity and Regatta Master line of products (multi-manager products) represented $627 million of total annuity deposits for the year ended December 31, 2002.
Policyholder benefits increased by approximately $21 million for the year ended December 31, 2002 as compared to 2001. Reserves related to the single premium pension policies increased by $38 million as a result of changes in the mortality assumptions used to calculate the reserves. The mortality was adjusted to reflect expected payment and as a result a loss was recognized on that line of business. Additionally, benefits paid over policyholder account balances due to the guaranteed minimum death benefit contracts increased by $32 million over 2001. Offsetting these increases were lower bonus payments and lower interest credited to policyholder accounts. One set of annuity products credit the policyholder's account with a bonus payment upon receipt of the deposit; the expense is included in annuity payments. As a result of the reduced sales of the bonus annuity products, bonus payments of $10 million for the year 2002 were $15 million lower than the $25 million of bonus payments made during the year 2001. Additionally, interest credited to policyholders declined by $46 million over prior year as a result of lower account values and lower interest rates.
Underwriting, acquisition and other operating expenses increased by $17 million for the year ended December 31, 2002, as compared to the same period in 2001. The Company experienced increased operating expenses within its investment adviser and distribution subsidiaries reflecting increased volumes of new business, most of which can be attributed to the acquisitions of Keyport and its affiliates by the Company's parent. The increase in the subsidiaries operating expenses were offset by the increase fees noted above.
Amortization of DAC increased by $116 million for the year ended December 31, 2002, as compared to the same period in 2001. This increase is the result of unfavorable changes in actual and estimated future gross profit assumptions used to calculate amortization of DAC. The significant changes affecting future gross profit assumptions that increased DAC amortization during 2002 were the decline in the market value of separate account assets ($57.0 million) and revised cash flow assumptions ($39.0 million).
The Wealth Management segment was significantly impacted by unfavorable changes in the financial markets. The net loss of $11.1 million for the year ended December 31, 2001 was $5.1 million greater than the $6.0 million net loss for the year ended December 31, 2000. The losses in both years were primarily due to three factors: 1) increased amortization of DAC on annuity products; 2) increased strain associated with the successful introduction of new products which credit the policyholder with a bonus upon receipt of the deposit; 3) and changes in the market values of derivatives used to manage Wealth Management liabilities. Changes in estimated future gross profit assumptions used to amortize DAC resulted in cumulative adjustments that were included with current period amortization. The bonus credits on the new products were expensed as they were credited to the policyholders' account values. The changes in market values of derivative instruments were included in investment income. Additional details of the major factors affecting the Wealth Management segment's results for the year ended December 31, 2001 as compared to the same period in 2000 are as follows:
Annuity surrenders decreased in 2001 by $269 million. The surrenders were primarily from older products which are no longer actively marketed and the decrease was mainly due to the decline in market values of the variable annuity assets.
Net investment income and realized gains for the Wealth Management segment decreased by $7.5 million for the year ended December 31, 2001, as compared to 2000. The new GIC products that were introduced during the second quarter of 2000 generated an increase of $22 million of net investment income and net realized gains during 2001 as compared to $11 million of losses in 2000. Offsetting the increase from the new GIC products was a reduction in net investment income, reflecting the Company's 1997 decision to no longer market group pension and GIC products in the U.S., which caused an overall reduction in the block of in-force business of U.S. issued GIC's.
Wealth Management's net investment income was also reduced by the unrealized losses of the various derivative instruments which the Company used as part of its asset-liability management programs. The investment portfolio experienced unrealized gains on fixed bonds due to lower interest rates at December 31, 2001; however, the majority of the derivative instruments swapped fixed for floating rates and reflected unrealized losses. The swap spreads decreased more than the bond spreads increased, thereby reducing investment income. Total net losses on derivatives reduced Wealth Management pretax net income by $90 million for the year ended December 31, 2001, as compared to a total reduction of $61 million in 2000. Despite significant losses on derivatives associated with the new GIC's, the Company's exposure was limited due to the structure of payment terms at maturity. The contract liabilities were carried at account value and were included with policyholder liabilities.
Underwriting, acquisition and other operating expenses decreased by $8 million for the year ended December 31, 2001, as compared to the same period in 2000, reflecting the decreased volumes of both new business and in-force business.
Amortization of DAC decreased by $2 million for the year ended December 31, 2001 as compared to the same period in 2000. Both years experienced significant cumulative adjustments to amortization as a result of unfavorable changes in estimated future gross profit assumptions used to calculate amortization of DAC.
The Company currently markets variable life insurance products. These products include variable universal life ("VUL") products marketed to the corporate-owned life insurance ("COLI") and bank-owned life insurance ("BOLI") markets, which were first introduced in late 1997 and 1999, respectively. In September 1999, the Company introduced a new VUL product as part of the Futurity product portfolio. VUL products are insurance products that allow for flexible premiums and the policyholder directs how the cash value is invested, and thus bears the investment risk. The Company's management expects the variable life business to grow and become more significant in the future.
Earnings from the Individual Protection segment decreased by $2.9 million in 2002 as compared to 2001. Net income was $0.5 million for the year ended December 31, 2002 and $3.4 million for the year ended December 31, 2001. During 2002, the Company received $981 million of deposits into its COLI VUL and Futurity variable universal life products and its privately placed BOLI product. This new business combined with existing business in these product lines resulted in increased fee income of approximately $30 million for the year ended December 31, 2002. These fee increases were partially offset by increased operating expenses of $17.6 million, primarily due to growth in new business with premium taxes contributing $12.3 million of the total increase. Additionally, DAC amortization expense for the year ended December 31, 2002 was $7.1 million greater than the year ended December 31, 2001 due to significant favorable cumulative adjustments to DAC recorded in 2001. Reserves for the year ended December 31, 2002 increased by $6.8 million over the year ended December 31, 2001, primarily as the result of revised cash flows for reinsurance recoverables.
Earnings from the Individual Protection segment increased by $3.6 million, from a net loss of $0.2 million for the year ended December 31, 2000 to net income of $3.4 million for the year ended December 31, 2001, due primarily to increases in cost of insurance charges, and favorable DAC amortization as a result of favorable cumulative adjustments. During 2000, the Company received $850 million of deposits to its new privately placed BOLI VUL products. This resulted in increased fee income of $17 million that was offset by increased acquisition costs associated with the sales. During the year ended December 31, 2001, the Company received deposits of $380 million.
General account assets increased by 9.0% in 2002 and separate account assets decreased by 17.6%. The significant decline in separate account assets reflects the unfavorable financial market conditions that prevailed during 2002. Decreased net deposits into variable annuity product accounts combined with market depreciation of variable account assets have significantly reduced assets. The growth in the general account is primarily due to GIC products marketed overseas which had net deposits of $501 million for the year ended December 31, 2002.
The Company held $5.57 billion and $4.98 billion in invested assets at December 31, 2002 and 2001, respectively. The Company pursues a high-quality, well diversified portfolio strategy that is appropriate for its general fund obligations. The investment function is a critical component of the Company's business given the role invested assets play in supporting its product lines and the direct impact of investment results on profitability.
The Company's primary investment objective is to maximize after-tax returns on the products it issues within acceptable risk parameters. The Company is exposed to two primary types of investment risk:
Interest rate risk, meaning changes in the market value of fixed maturity securities and certain interest-sensitive liabilities as interest rates change over time, and
For a more detailed discussion of the Company's interest rate risk management policies, practices and procedures, please see the Interest Rate Risk Management section in the Quantitative and Qualitative Disclosures about Market Risk section of this annual report (Item 7A).
Within the pricing of the Company's products it has embedded provisions for expected default losses over the long term. This expectation is reassessed on a regular basis to determine the adequacy of the provision. However, actual losses may prove to be above or below the expected loss rate. The overall economic environment will also impact the market value of the portfolio through both interest rate changes and the response of credit spreads to changes in the business cycle. The Company's credit function and capital base generally permit it to pursue a buy and hold strategy which balances the Company's assets and liabilities with the intent of withstanding near-term swings in the broader economy.
The fixed maturity portion of the portfolio consists of publicly traded and privately placed debt securities. The Company diversifies its fixed maturities by industry sectors, government (domestic and foreign), and mortgaged-back and asset-backed securities. Asset-backed securities include structured equipment and receivable investments.
The following provides the composition of the Company's fixed maturity portfolio by sector and the unrealized gains and losses contained therein as of December 31, 2002 (in 000's):
: The Basic Industry sector is composed of the chemicals, metals and paper and forest products industries. Broadly, these sectors supply commodity products for use as an end product or as input for higher value-added goods. Demand typically fluctuates with the strength of the economy. As would be expected, continued weak demand has led to falling unit prices, lower capacity utilization, and declining profitability for many industry participants. Those companies with highly-leveraged balance sheets may have experienced ratings deterioration to below investment grade classifications, or are at risk for such. A rebound in industry profitability may be delayed until the domestic and/or world economies show prolonged strength and capital spending resumes. In the interim, the portfolios are comprised of well-run companies with specialty niches or with dominant industry positions that have allowed them to withstand the market weakness and avoid significant market-value deterioration.
construction machinery demand had been underperforming, in general, the Company has seen improved balance sheets and operational efficiencies as these firms position for market recovery. In the environmental service sector poor economic conditions have affected volume and revenue growth, yet companies in this sector continue to apply strong free cash flow to improve their financial flexibility. While the capital goods subsectors have had varying operating histories, the Company is comfortable with issuer concentration and prospects.
: The Energy sector encompasses the oil and gas industries. Higher commodity prices in the second half of 2002 contributed to the earnings of most oil and gas companies - namely exploration and production, integrateds and, to a lesser extent, refineries. Investments in these sectors, in general, provided solid returns during the year. Oil field services, however, did not fare as well due to a redirection by the integrateds towards increasing reserves through acquisition rather than exploration. Political turmoil in Venezuela caused that country's oil production to suffer near complete shutdown after workers went on strike at the oilfields and refineries. Although bond values of Venezuela's national oil company suffered considerable declines, the structure of the Company's holdings in this entity continues to provide investment protection.
: The Technology sector is comprised of computer hardware manufacturers, makers of mainframe, client/server and personal computers as well as computer software and services manufacturers. The fundamentals of the technology sector remained weak as global information technology ("IT") spending remained severely depressed in 2002. Industry analysts have indicated that there is no near term catalyst that could restore sales back to the levels seen in the late 1990s, when strong demand driven by the technological advancement of personal computers, cell phones and telecom equipment often outpaced supply growth. Currently, excess supply continues to undermine pricing. Most industry analysts expect a modest improvement in IT spending this year after several years of depressed demand. The Company remains comfortable with its limited issuer and industry exposure in this sector.
: The Utilities sector includes regulated electric and gas utilities, regulated interstate pipelines, merchant energy companies and independent power projects. The continuation of unresolved California energy crisis issues as well as the fallout from the late 2001 Enron bankruptcy, Federal Energy Regulatory Commission and Securities and Exchange Commission investigations, accounting restatements, accounting rule changes, shareholder litigation, and depressed commodity prices placed unprecedented pressure on the sector. Liquidity became the primary focus for the sector, a situation greatly exacerbated by rapid, and in some cases, multiple level downgrades by the credit rating agencies. The Company's portfolio is diversified to include many regulated utilities, interstate pipelines and utility holding companies that have been less affected during the year. In the cases where the portfolio's utility holdings have been negatively impacted, ongoing analysis of both firm-specific asset values and projected industry economics drive the Company's investment conclusions. In fact, the Company expects the industry to benefit in the intermediate term from a focus on balance sheet repair, including reduced capital expenditure, reduced dividends, asset sales and equity issuance. The ongoing progress in industry restructuring supports the Company's intention to hold its positions until maturity or recovery.
The composition by credit quality of the securities with gross unrealized losses in the fixed maturity securities portfolio was as follows at December 31, 2002 (in 000's):
The Company has a comprehensive process in place to identify potential problem securities that could have an impairment that is other-than-temporary. At the end of each quarter, all securities with a market value below 80% of amortized cost are reviewed. An analysis is undertaken to determine whether this decline in market value is other- than-temporary. The Company's process focuses on issuer operating performance as well as overall industry and market conditions. Any deterioration in operating performance is assessed relative to the impact on financial ratios including leverage and coverage measures specific to an industry and relative to any investment covenants. Additionally, the Company's analysis assesses each issuer's ability to service its debts in a timely fashion, the length of time the security has been trading below 80% of amortized cost, rating agency actions, and any other key developments. The Chief Investment Officer and the Chief Financial Officer review the results of the impairment analysis.
Securities that have been triggered for the impairment review process may either be determined to be impaired or placed on a watchlist for monitoring. Should it be determined that a security is impaired, the Company may sell the security and realize a loss or hold the security following an appropriate adjustment in carrying value to reflect expected recovery. During 2002 and 2001, the Company incurred write-downs of fixed maturities totaling $27.5 million and $5.5 million, respectively, for other-than-temporary impairment. The 2002 write-downs reflect impairments primarily relating to the Transportation, Energy and Utilities sectors. Realized losses on the voluntary sale of fixed maturity securities totaled $6.3 million in 2002 compared to $7.0 million in 2001.
The fair value of fixed maturity securities with unrealized losses by maturity date as of December 31, 2002 was as follows (in 000's):
The Company's liquidity targets are intended to enable it to meet its day-to-day cash requirements. On a quarterly basis, the Company compares its total "liquid" assets to its total demand liabilities. Liquid assets comprise cash and assets that could quickly be converted to cash should the need arise. These assets include short-term investments and other current assets and investment-grade bonds. The Company's policy is to maintain a liquidity ratio in excess of 100%. The Company believes that its available liquidity is sufficient to meet its liquidity needs.
The Company has made commitments of mortgage loans on real estate into the future. The outstanding commitments for these mortgages amount to $12.1 million and $39.8 million at December 31, 2002 and 2001, respectively.
On December 18, 2002, the Company sold all of the outstanding shares of SLD, a registered broker-dealer and investment advisor, to SLF Holdings, an affiliate. Effective January 1, 2003, SLD changed its name to MFSLF, and thereafter MFS, an affiliate of the Company, acquired a 50% ownership interest in MFSLF. The proceeds from this sale were $10.5 million and no gain or loss was realized on this transaction.
On June 1, 2000, the Company sold all of the outstanding shares of Sun Life Information Services Ireland, Limited ("SLISL") to SLOC. SLISL provides information systems development services to SLOC and its subsidiaries. The Company realized a post-tax gain of approximately $293,000 on this transaction.
On December 21, 2000, the Company's parent, SLC (U.S.) Holdings, transferred its $350 million SLOC subordinated note to Sun Canada Financial Co., an affiliate, in the form of additional capitalization. On the same day, Sun Canada Financial Co. transferred its ownership in the Company's surplus notes totaling $315 million to SLC (U.S.) Holdings in the form of a dividend. As a result, the Company had $565 million of surplus notes issued to its parent, SLC (U.S.) Holdings, as of December 31, 2000.
During 2002, the Company contributed $6 million of additional paid-in capital to SLD, formerly a wholly-owned subsidiary.
On May 29, 2002, the Company sold its $100 million note from MFS, an affiliate, to Keyport, another affiliate, for approximately $108 million. The note was included in fixed maturities available-for-sale at December 31, 2001. A gain of $8 million was recognized on this transaction.
Trading fixed maturities at fair value (amortized cost of $1,354,969 and
On December 31, 2002, the operations of Sun Life Assurance and Annuity Company of New York, were merged with another affiliated company, Keyport Benefit Life Insurance Company. As a result of this merger Keyport Life Insurance Company, the former parent company of Keyport Benefit Life Insurance Company and an affiliate of the Company, owns 67% of the combined entity and the Company retained a 33% interest in the combined entity.
Sun Life Assurance Company of Canada (U.S.) (the "Company") was incorporated in 1970 as a life insurance company domiciled in the state of Delaware. As of December 31, 2002, the Company was licensed in 48 states and certain other territories. Effective January 31, 2001, the Company became authorized to do business in 49 states. In addition, the Company's insurance affiliate, Sun Life Insurance and Annuity Company of New York ("SLNY"), is licensed in New York. The Company and its subsidiaries are engaged in the sale of individual and group variable life insurance, individual fixed and variable annuities, group fixed and variable annuities, group pension contracts, guaranteed investment contracts ("GICs"), group life, group disability and stop loss insurance, third party insurance administration, and other asset management services.
The financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for stockholder-owned life insurance companies.
On December 18, 2002 the Company sold its interest in its' wholly-owned subsidiary, Sun Life of Canada (U.S.) Distributors, Inc. ("SLD") to another affiliate, Sun Life Financial (U.S.) Holdings, Inc. ("SLF Holdings"), for $10.5 million. No gain or loss was realized on this transaction. Effective January 1, 2003, SLD changed its name to MFS/Sun Life Financial Distributors, Inc. ("MFSLF") and thereafter Massachusetts Financial Services Company ("MFS"), an affiliate of the Company, acquired a 50% ownership interest in MFSLF.
SLNY is engaged in the sale of individual fixed and variable annuity contracts and group life, group disability insurance and stop loss contracts in its state of domicile, New York. SLFSL serves as the marketing administrator for the distribution of the offshore products of SLOC, an affiliate. SCA is a registered investment adviser. SPE 97-I, was organized for the purpose of engaging in activities incidental to securitizing mortgage loans. The General Partner is the sole general partner of the Partnership. Clarendon is a registered broker-dealer that acts as the general distributor of certain annuity and life insurance contracts issued by the Company and its affiliates. As of December 31, 2002, SBSC was inactive. SLOC Funding, was organized for the purpose of engaging in activities incidental to establishing the new guaranteed investment products of the Company. The Partnership was established to purchase subordinated debentures issued by the Company's parent, SLF Holdings, and to issue Partnership capital securities to an affiliated business trust, Sun Life of Canada (U.S.) Capital Trust I, ("Capital Trust I").
Cash and cash equivalents primarily include cash, commercial paper, money market investments, and short-term bank participations. All such investments have maturities of three months or less when purchased and are considered cash equivalents for purposes of reporting cash flows.
The Company accounts for its investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." At the time of purchase, fixed maturity securities are classified based on intent, as held-to-maturity, trading, or available-for-sale. In order for the security to be classified as held-to-maturity, the Company must have positive intent and ability to hold the securities to maturity. Securities held-to-maturity are stated at cost adjusted for amortization of premiums and accretion of discounts. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading. Securities that do not meet this criterion are classified as available-for-sale. Available-for-sale securities are carried at aggregate fair value with changes in unrealized gains or losses reported net of amortization of DAC and of deferred income taxes in a separate component of other comprehensive income. Trading securities are carried at aggregate fair value with changes in unrealized gains or losses reported as a component of net investment income. Fair values for publicly traded securities are obtained from external market quotations. For privately placed fixed maturities, fair values are estimated by taking into account prices for publicly traded securities of similar credit risk, maturities repayment and liquidity characteristics. All security transactions are recorded on a trade date basis.
A loan is recognized as impaired when it is probable that the principal or interest is not collectible in accordance with the contractual terms of the loan. Measurement of impairment is based on the present value of expected future cash flows discounted at the loan's effective interest rate, or at the loan's observable market price. A specific valuation allowance is established if the fair value of the impaired loan is less than the recorded amount. Loans are also charged against the allowance when determined to be uncollectible. The allowance is based on a continuing review of the loan portfolio, past loss experience and current economic conditions, which may affect the borrower's ability to pay. While management believes that it uses the best information available to establish the allowance, future adjustments to the allowance may become necessary if economic conditions differ from the assumptions used in making the evaluation.
Other invested assets consist primarily of a leveraged lease, derivative investments and tax credit partnerships.
Property, equipment, leasehold improvements and capitalized software costs that are included in other assets are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line or accelerated method over the estimated useful lives of the related assets, which generally range from 3 to 10 years. Amortization of leasehold improvements is provided using the straight-line method over the lesser of the term of the leases or the estimated useful life of the improvements. Reinsurance receivables from reinsurance ceded are also included in other assets.
Contractholder deposit funds consist of policy values that accrue to the holders of universal life-type contracts and investment-related products such as deferred annuities and guaranteed investment contracts ("GICS"). The liabilities are determined using the retrospective deposit method and consist of net deposits and investment earnings less administrative charges. The liability is before the deduction of any applicable surrender charges.
Other than DAC, benefits and expenses related to traditional life, annuity, and disability contracts, including group policies, are recognized when incurred in a manner designed to match them with related premium revenue and spread income recognition over expected policy lives. For universal life-type and investment-type contracts, benefits include interest credited to policyholders' accounts and death benefits in excess of account values, which are recognized as incurred.
Fees from investment advisory services are recognized as revenues when the services are provided. Revenues from fixed and variable annuities and single-premium whole life policies include mortality charges, surrender charges, policy fees and contract fees and are recognized when earned.
The Company and its subsidiaries participate in a consolidated federal income tax return with Sun Life Assurance Company of Canada - U.S. Operations Holdings, Inc. and other affiliates. Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences as defined by SFAS No. 109, "Accounting for Income Taxes". These differences result primarily from policy reserves, policy acquisition expenses and unrealized gains or losses on investments.
In November of 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others" ("FIN No. 45"). FIN No. 45 requires entities to establish liabilities for certain types of guarantees, and expands financial statement disclosures for others. Disclosure requirements under FIN No. 45 are effective for financial statements of annual periods ending after December 15, 2002 and are applicable to all guarantees issued by the guarantor subject to the provisions of FIN No. 45. The initial recognition and measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company does not expect the adoption of FIN No. 45 to have a significant impact on the Company's consolidated financial statements. FIN No. 45 did not require the Company to include any additional disclosures related to guarantees in the financial statements for the year ended December 31, 2002.
The Company, through its subsidiary, SCA, may have to consolidate, Solar Investment Grade CBO II Limited, the special purpose entity ("SPE") used to facilitate the collateralized debt offering SOLAR CBO II. As of December 31, 2002 the assets and liabilities of this entity were approximately $409.0 million and $407.0 million, respectively. The actual amount that may be consolidated is dependent on the analysis of expected losses and residual returns as compared to the other equity holders and sub-collateral managers. The Company's maximum exposure to loss as a result of its investment is approximately $9.8 million at December 31, 2002.
In July 2002, the American Institute of Certified Public Accountants ("AICPA") issued a proposed Statement of Position ("SOP"), "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Separate Accounts." This SOP provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts. The Company is in the process of evaluating the provisions of this SOP and its impact to the Company's financial position or results of operations.
On May 29, 2002, the Company sold its $100 million note from MFS, an affiliate, to Keyport, another affiliate, for approximately $108 million. The note was included in fixed maturities available-for-sale at December 31, 2001. The note was sold at a gain of $8 million.
During 2001 and 2000, the Company declared and paid dividends in the amount of $15 million, and $10 million, respectively, to its parent, SLC (U.S.) Holdings. The Company did not make any dividend payments in 2002.
The following proforma statement of income for the year ended December 31, 2000 illustrates the Company's results of operations as if the acquisition of the General Partner took place at the beginning of the year.
Effective January 2002, essentially all United States employees of Keyport, an affiliate, and SLOC became employees of the Company. As a result, the Company has assumed most of the operating expenses of Keyport, including salaries and benefits, as well as the salaries and benefits previously incurred by SLOC in the United States. In accordance with a tri-party management service agreement between the Company, Keyport, and SLOC, the Company provides personnel and certain services to Keyport and SLOC, as requested. Reimbursements under this agreement, which are recorded as a reduction of other operating expenses, were approximately $51.7 million for the year ended December 31, 2002. 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 standalone basis.
The Company leases office space to SLOC under lease agreements with terms expiring in September 2005 and options to extend the terms for each of twelve successive five year terms at fair market value of the fixed rent for the term which is ending. Rent received by the Company under the leases amounted to approximately $11.7 million, $8.8 million, and $7.8 million in 2002, 2001 and 2000, respectively.
The Company had $565 million of surplus notes issued to its parent, SLC (U.S.) Holdings, as of December 31, 2000. In October 2001, SLC (U.S.) Holdings transferred its ownership in the Company's surplus notes totaling $565 million to Sun Life Financial (U.S.) Finance, Inc., an affiliate of the Company, at book value.
Gross gains of $28.1 million, $15.5 million and $9.1 million and gross losses of $6.3 million, $7.0 million and $24.0 were realized on the voluntary sale of fixed maturities for the years ended December 31, 2002, 2001, and 2000, respectively.
At December 31, 2002 and 2001, $37.0 million and $32.9 million of fixed maturities were pledged as collateral and are included with fixed maturities.
Real estate held for the production of income primarily consists of the Sun Life office park located in Wellesley Hills, MA. Accumulated depreciation on real estate was $17.9 million and $16.1 million at December 31, 2002 and 2001, respectively.
The investment valuation allowances, which have been deducted in arriving at investment carrying values as presented in the consolidated balance sheets, were as follows:
At December 31, 2002, scheduled mortgage loan maturities were as follows:
During 2002 and 2000, the Company sold commercial mortgage loans in securitization transactions. In these transactions the Company established a trust, as a Qualified SPE to purchase the assets and issue the trust certificates. In the transactions, the Company retained investment tranches as well as servicing rights. The investors in the securitization trusts have no recourse to the Company's other assets for failure of debtors to pay when due. The value of the Company's retained interest is subject to credit and interest rate risk on the transferred financial assets. The Company recognized a pretax gain of $4.5 million and $763,000 for the 2002 and 2000 securitization transactions, respectively.
Key economic assumptions and the sensitivity of the current fair value of cash flows in those assumptions are as follows:
The total principal amount of the commercial mortgage loans was $165.8 million at December 31, 2002, none of which were 60 days or more past due. There were no net credit losses incurred relating to the commercial mortgage loans at the date of securitization and at December 31, 2002.
The Company has a securities lending program operated on its behalf by the Company's primary custodian, Chase Manhattan Bank of New York. The custodian has indemnified the Company against losses arising from this program. There were no securities out on loan at December 31, 2002 and 2001. The income resulting from this program was $252,000, $126,000, and $48,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
The Company is a lessor in a leverage lease agreement entered into on October 21, 1994, under which equipment having an estimated economic life of 25-40 years was originally leased for a term of 9.78 years. During 2001, the lease term was extended until 2010. The Company's equity investment represented 22.9% of the purchase price of the equipment. The balance of the purchase price was furnished by third-party long-term debt financing, collateralized by the equipment and non-recourse to the Company. At the end of the lease term, the master lessee may exercise a fixed price purchase option to purchase the equipment. The Company's net investment in leveraged leases is composed of the following elements:
The net (decrease) increase in net investment income related to swap settlement payments was $(34.2) million, $(23.5) million, and $.2 million for the years ended December 31, 2002, 2001 and 2000, respectively.
The net increase (decrease) in net investment income related to changes in the fair value of options was $9.0 million, $(28.9) million and $(13.5) million for the years ended December 31, 2002, 2001 and 2000, respectively. The Company does not employ hedge accounting treatment. As a result, changes in the fair value of swaps are reported in current period operations as a component of net investment income.
The following table presents the carrying amounts and estimated fair values of the Company's financial instruments at December 31, 2002 and 2001:
The fair values of cash and cash equivalents are estimated to be cost plus accrued interest. The fair values of short-term bonds are estimated to be amortized cost. The fair values of publicly traded fixed maturities are based upon market prices or dealer quotes. For privately placed fixed maturities, fair values are estimated by taking into account prices for publicly traded securities of similar credit risk, maturity, repayment and liquidity characteristics. The fair values of mortgage and other 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.
The fair values of the Company's general account insurance reserves and contractholder deposits under investment-type contracts (insurance, annuity and pension contracts that do not involve mortality or morbidity risks) are estimated using discounted cash flow analyses or surrender values based on interest rates currently being offered for similar contracts with maturities consistent with those remaining for all contracts being valued. Those contracts that are deemed to have short-term guarantees have a carrying amount equal to the estimated market value.
The Company's funding policies for the pension plans are to contribute amounts which at least satisfy the minimum amount
The following table sets forth the change in the pension plan's projected benefit obligations and assets, as well as the plan's funded status at December 31 (in 000's):
The Company's share of the projected benefit obligation for the years ended December 31, 2001 and 2000 was $140.6 million and $109.7 million, respectively.
The Company's share of the fair value of plan assets at December 31, 2001 and 2000 was $177.3 million and $163.2 million, respectively.
The Company's share of the prepaid benefit costs at December 31, 2001 and 2000 was $29.2 million and $26.8 million, respectively.
The Company sponsors and participates in a 401(k) savings plan for which substantially all employees of at least age 21 are eligible for at date of hire. Under the plan, the Company matches up to specified amounts, the employees' contributions to the plan. The amount of the 2002 employer contributions under plan sponsorship for the Company and its affiliates was $4.03 million. Amounts are allocated to affiliates based on employees' contributions. The Company's portion of the expense was $956,000, $462,000 and $354,000 for the years ended December 31, 2002, 2001, and 2000, respectively.
Through December 31, 2001, the Company was a participant in a post-retirement benefit pension plan for employees sponsored by SLOC providing certain health, dental, and life insurance benefits ("post-retirement benefits") for retired employees and dependents. Consistent with the transfer of all employees to Sun Life of Canada U.S. on January 1, 2002, the plan sponsorship was transferred to the Company. Expenses are 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 table sets forth the change in other post-retirement benefit plans' obligations and assets, as well as the plans' funded status at December 31, 2002 (in 000's):
The Company's share of the net periodic benefit costs for the years ended December 31, 2001 and 2000 was $256,000 and $219,000 respectively.
In order to measure the post-retirement benefit obligation at December 31, 2002, the Company assumed a 12.0% annual rate of increase in the per capita cost of covered health care benefits. In addition, medical cost inflation is assumed to be 11% in 2003 and assumed to decrease gradually to 5.5% for 2013 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. For example, increasing the health care cost trend rate assumptions by one percentage point in each year would increase the accumulated post-retirement benefit obligation at December 31, 2002 by $4.3 million, and the aggregate of the service and interest cost components of net periodic post-retirement benefit expense for 2002 by $0.6 million. Conversely, decreasing assumed rates by one percentage point in each year would decrease the accumulated post-retirement benefit obligation at December 31, 2002 by $3.6 million, and the aggregate of the service and interest cost components of net periodic post-retirement benefit expense for 2002 by $0.5 million. The assumed weighted average discount rate used in determining the post-retirement benefit obligation was 6.75% for 2002, 7.00% for 2001 and 7.50% for 2000.
The Company regularly updates its estimates of liabilities for unpaid claims and claims adjustment expenses as new information becomes available and further events occur which may impact the resolution of unsettled claims for its group disability lines of business. Changes in prior estimates are recorded in results of operations in the year such changes are determined to be needed. As a result of the merger of SLNY and KBL, the liabilities of SLNY, including all of the group liabilities for Company, are no longer consolidated with the liabilities of the Company.
During 2002, DAC amortization was increased as a result of actual results and revised estimates of future gross profits. The change in the market value of separate accounts assets (approximately $57.0 million) and revised cash flow assumptions (approximately $39.0 million) were the major items affecting the change in gross profit assumptions
The Company offers financial products and services such as fixed and variable annuities, guaranteed investment contracts, retirement plan services, and life insurance on an individual and group basis, as well as disability insurance on a group basis. Within these areas, the Company conducts business principally in three operating segments and maintains a Corporate segment to provide for the capital needs of the three operating segments and to engage in other financing related activities. Net investment income is allocated based on segmented assets by line of business.
The Wealth Management segment markets and administers individual and group variable annuity products, individual and group fixed annuity products which include market value adjusted annuities, and other retirement benefit products. The Company began offering GICS to unrelated third parties in overseas markets during the second quarter of 2000. These contracts may contain any of a number of features including variable or fixed interest rates and equity index options and may be denominated in foreign currencies. The Company uses derivative instruments to manage the risks inherent in the contract options.
The Individual Protection segment markets and administers a variety of life insurance products sold to individuals and corporate owners of life insurance. The products include whole life, universal life and variable life products.
The Corporate segment includes the unallocated capital of the Company, its debt financing, and items not otherwise attributable to the other segments.
The following amounts pertain to the various business segments. Prior years segmented results have been restated to include the results of the Company's investment advisor subsidiary, SCA, with the Wealth Management segment instead of the Corporate segment:
The Company's statutory surplus and net income (loss) were as follows:
The Company's and its insurance affiliate's ability to pay dividends are subject to certain restrictions. Delaware and New York have enacted laws governing the payment of dividends to stockholders by insurers. These laws affect the dividend paying ability of the Company and SLNY. Pursuant to Delaware's statute, the maximum amount of dividends and other distributions that an insurer may pay in any twelve-month period, without prior approval of the Delaware Commissioner of Insurance, is limited to the greater of (i) 10% 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 (if such insurer is a life company), or its net income (not including realized capital gains) for the preceding calendar year (if such insurer is not a life company). Any dividends to be paid by an insurer, whether or not in excess of the aforementioned threshold, from a source other than statutory surplus, would also require the prior approval of the Delaware Commissioner of Insurance. The Company did not pay any dividends in 2002 and paid $15.0 million and $10.0 million of dividends to its parent, SLC (U.S.) Holdings, during 2001, and 2000, respectively.
The Company has syndicated two lines of credit each in the amount of $250 million. There are 15 banks in the syndicate of lenders. The banks have committed to lend funds of up to $500 million when requested by the Company at prevailing rates determined in accordance with the line of credit agreements. One line of credit terminates October 2003, the other in October 2007. As of December 31, 2002, no amounts have been borrowed.
We have audited the accompanying consolidated balance sheets of Sun Life Assurance Company of Canada (U.S.) and its subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of income, comprehensive income, stockholder's equity, and cash flows for each of the three years in the period ended December 31, 2002. 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.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sun life Assurance Company of Canada (U.S.) and its subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.