The Company also leases properties in Boston, Massachusetts. The Company is in the process of subleasing these properties.
VOBA transferred to SLNY under the SLHIC to SLNY asset transfer is amortized in proportion to the projected premium income over the period to the first renewal of the transferred business and, as such, is not adjusted for amounts relating to unrealized investment gains and losses.
A portion of the assets that were transferred to SLNY under the SLHIC to SLNY asset transfer are the value of customer renewals acquired. The value of customer renewals acquired represents the actuarially determined present value of projected future profits arising from the existing in-force business at May 31, 2007 to the next policy renewal date. This amount is amortized in proportion to the projected premium income over the period from the first renewal date to the end of the projected life of the policies and, as such, is not adjusted for amounts relating to unrealized investment gains and losses.
In the normal course of business, the Company enters into transactions involving various types of financial instruments. These instruments involve credit risk and may also be subject to risk of loss due to interest rate fluctuation. The Company monitors each financial instrument individually and, when appropriate, obtains collateral or other security to minimize losses.
The Company determines the fair value of its publicly traded fixed maturities using four primary pricing methods: third-party pricing services, independent dealer quotes, pricing matrices, and pricing models. Prices are first sought from third-party pricing services; the remaining unpriced securities are priced using one of the remaining three methods. Third-party pricing services derive the security prices through recently reported trades for identical or similar securities with adjustments for trading volumes and market observable information through the reporting date. In the event that there are no recent market trades, pricing services and brokers may use pricing matrices and models to develop a security price based on future expected cash flows discounted at an estimated market rate using collateral performance and vintages.
Certain of the Company’s 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 fair value of swaps is based on current settlement values. The current settlement values are based on dealer quotes or market prices. Fair values for options and futures are based on dealer quotes or market prices.
The Company's accounting policy for impairment requires recognition of an other-than-temporary impairment write-down on a security if it is determined that the Company anticipates that it will be unable to recover all amounts due under the contractual obligations of the security. Additionally, in the event that securities that are expected to be sold before the fair value of the security recovers to amortized cost, an other than temporary impairment charge is also taken.
The Company incurred realized losses totaling $68.1 million and $6.3 million, for the years ended December 31, 2007 and 2006, respectively, for other-than-temporary impairments. Of the $68.1 million realized losses for other-than-temporary impairments for the year ended December 31, 2007, $16.1 million was due to a change in the Company’s intent to hold the securities to recovery of fair value, up to amortized cost. The remaining $52 million of realized losses were credit-related.
Goodwill represents the difference between the purchase price paid and the fair value of the net assets acquired in connection with the Company’s acquisition of Keyport on November 1, 2001 and the transfer of goodwill to SLNY based on the SLHIC to SLNY asset transfer, effective May 31, 2007. Goodwill obtained in connection with the purchase of Keyport is allocated to the Wealth Management Segment. Goodwill obtained through the SLHIC to SLNY asset transfer is allocated to the Group Segment in the Company’s subsidiary, SLNY. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is tested for impairment on an annual basis. The Company completed the required impairment tests of goodwill and indefinite-lived intangible assets during the second quarter of 2007 and concluded that these assets were not impaired.
Premium and annuity considerations - were $110.6 million and $59.2 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The $51.4 million increase is primarily attributed to a $33.8 million increase in group disability premiums, $10.1 million increase in group health premiums, $9.0 million increase in group life premium, and $4.6 million increase in group stop loss premiums, partially offset by $5.6 million decrease in annuity premiums. The increases in the group line of business were primarily due to the SLHIC to SLNY asset transfer.
Net investment income - was $1,098.6 million and $1,206.1 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. Investment income, excluding the mark to market of the trading portfolio and partnership income, was $1,159.3 million and $1,161.3 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The decrease of $2.0 million during 2007, as compared to 2006, was the result of a decrease in average invested assets which decreased investment income by $51.0 million, offset by a higher average investment yield which increased investment income by $49.0 million. Investment (loss) income related to the changes in the market value of securities in the trading portfolio and changes in the value of the partnership investments was $(60.7) million and $44.8 million for the twelve-month periods ended December 31, 2007 and 2006, respectively.
Net derivative (loss) income for the years ended December 31 consisted of the following (in 000’s):
Net realized investment losses - were $61.0 million and $44.5 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The Company incurred write-downs of fixed maturities for other-than-temporary impairments of $68.1 million and $6.3 million for the twelve-month periods ended December 31, 2007 and 2006, respectively.
Other income primarily represents fees charged for administrative services fee, cost of insurance, investment advisory services and asset participation fees. Other income was $146.3 million and $108.8 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. Of the $37.5 million increase in other income, $24.2 million resulted from increased sales of bank-owned life insurance ("BOLI") and $13.3 million resulted from the growth of in-force business, increased asset participation fees, and other fees.
Subordinated notes early redemption premium was the premium received from the Parent in connection with the early redemption of a $600 million subordinated note. The early redemption premium was $25.6 million for the year ended December 31, 2007.
Total benefits and expenses were $1,459.4 million and $1,551.8 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The decrease of $92.4 million was primarily due to the following:
Amortization of DAC - relates to the costs of acquiring new business, which vary with and are primarily related to the production of new business. Such acquisition costs include commissions, costs of policy issuance, and underwriting and selling expenses. Amortization expense was $169.8 million and $391.6 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The amortization expense included the effect of revisions in estimated gross profits which aggregated $(16.0) million and $143.9 million for the years ended December 31, 2007 and 2006, respectively. Decreased actual gross profits contributed to the decrease in DAC amortization for the year ended December 31, 2007. The most significant assumption changes for the year ended December 31, 2006 related to assumptions regarding lapses, future growth rates of capital markets assumptions and expense assumptions.
Amortization of VOBA - relates to the actuarially-determined value of in-force business at the dates that the Company acquired Keyport (i.e., November 1, 2001) and EBG (i.e., May 31, 2007). This amount is amortized in proportion to the projected emergence of profits or premium income over the estimated lives of the contracts. Amortization was $19.3 million and $7.6 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The amortization expense was increased (decreased) resulting from an unlocking adjustment of $0.5 million and $(8.3) million for the years ended December 31, 2007 and 2006, respectively.
The segment’s principal products are described below for the years ended December 31, 2007 and 2006:
Fixed Index Annuities - Fixed index annuities credit interest to the policyholder using a formula based upon the positive change in value of a specified equity index. The Company’s fixed index annuity products calculate interest earnings using the S&P 500 Index. The Company’s fixed index products also provide a guarantee of principal (less withdrawals) at the end of the term or surrender charge period.
On September 12, 2006, the Company entered into a Terms Agreement (the "2006-B Terms Agreement") with its affiliates Sun Life Financial Global Funding III, L.P. (the "Issuer III"), Sun Life Financial Global Funding III, U.L.C. (the "ULC III") and Sun Life Financial Global Funding III, L.L.C. (the "LLC III"), and with Citigroup Global Markets, Inc., Deutsche Bank Securities Inc., Morgan Stanley & Co. Incorporated, Banc of America Securities LLC, Credit Suisse Securities (USA) LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated,, RBC Capital Markets Corporation and Wachovia Capital Markets (each, an "Initial Purchaser" and collectively, the "2006-B Initial Purchasers"), in connection with the offer and sale by the Issuer III of $750 million of Series 2006-1 Floating Rate Notes due 2013 ("2006-B Notes"). On September 21, 2006, the Company entered into another Terms Agreement (together with the original 2006-B Terms Agreement, the "2006-B Terms Agreements") with the same parties as the original 2006-B Terms Agreement in connection with the offer and sale by the Issuer III of a second tranche of $150 million of 2006-B Notes. The payment obligations of the Issuer III for the full $900 million of 2006-B Notes are unconditionally guaranteed by the LLC III pursuant to a guarantee (the "2006-B Secured Guarantee") dated as of September 19, 2006, and the obligations of the LLC III under the 2006-B Secured Guarantee are secured by two floating rate funding agreements issued by the Company to the LLC III, one for $750 million issued on September 19, 2006 and another for $150 million issued on September 29, 2006. Total interest credited for the funding agreements was $51.6 million and $14.9 million for the years ended December 31, 2007 and 2006, respectively.
On May 17, 2006, the Company entered into a Terms Agreement (the "2006-A Terms Agreement") with its affiliates Sun Life Financial Global Funding II, L.P. (the "Issuer II"), Sun Life Financial Global Funding II, U.L.C. (the "ULC II") and Sun Life Financial Global Funding II, L.L.C. (the "LLC II"), and with Citigroup Global Markets, Inc. ("Citigroup"), Morgan Stanley & Co. Incorporated ("Morgan Stanley"), Banc of America Securities LLC, Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated and RBC Capital Markets Corporation (collectively, with Citigroup and Morgan Stanley, the "2006-A Initial Purchasers"), in connection with the offer and sale by the Issuer II of $900 million of Series 2006-1 Floating Rate Notes due 2011 (the "2006-A Notes"). The payment obligations of the Issuer II are unconditionally guaranteed by the LLC II pursuant to a guarantee (the "2006-A Secured Guarantee"), and the obligations of the LLC II under the 2006-A Secured Guarantee are secured by a $900 million floating rate funding agreement issued by the Company to the LLC II. The 2006-A Terms Agreement incorporates by reference the provisions of a Purchase Agreement dated as of May 15, 2006 by and among the Issuer II, the ULC II, the LLC II, the Company and the 2006-A Initial Purchasers. Pursuant to these incorporated provisions, the Company has agreed, among other things, to indemnify each 2006 Initial Purchaser against certain securities law liabilities related to the offering of the 2006-A Notes. Total interest credited for the funding agreement was $50.8 million and $30.7 million for the years ended December 31, 2007 and 2006, respectively.
On May 24, 2006, the Company also issued a $100 million floating rate demand note payable to the LLC II. The Company expensed $5.7 million and $3.4 million for interest on the demand note for the year ended December 31, 2007 and 2006, respectively.
The Company has entered into an interest rate swap agreement with the LLC II with a notional amount of $900 million that effectively converts the floating rate payment obligations under the funding agreement to fixed rate obligations.
Other - The Wealth Management Segment manages a closed block of single premium whole life (“SPWL”) policies, a retirement-oriented tax-advantaged life insurance product. The Company discontinued sales of the SPWL policies in response to certain tax law changes in the 1980s. The Company had SPWL policyholder balances of $1.6 billion and $1.6 billion as of December 31, 2007 and 2006, respectively.
The pre-tax (loss) income was $(51.7) million and $32.1 million for the years ended December 31, 2007 and 2006, respectively. The significant changes are described below.
Total revenues were $1,087.8 million and $1,386.6 million for the years ended December 31, 2007 and 2006, respectively. The decrease of $298.8 million was primarily due to the following:
Net derivative (loss) income - was $(190.8) million and $5.0 million for the years ended December 31, 2007 and 2006, respectively.
Net derivative (loss) income for the segment for the years ended December 31, consisted of the following (in 000’s):
Realized investment losses - were $61.3 million and $34.6 million for the years ended December 31, 2007 and 2006, respectively. The Wealth Management Segment incurred write-downs of fixed maturities for other-than-temporary impairments of $66.2 million and $4.2 million for the years ended December 31, 2007 and 2006, respectively.
Surrender charges represent revenues earned on the early withdrawal of fixed, fixed index and variable annuity policyholder balances. Surrender charges on fixed, fixed index and variable annuity surrenders generally are assessed at declining rates applied to policyholder surrenders during the first four to seven years of the contract. Total surrender charges were $20.5 million and $25.7 million for the years ended December 31, 2007 and 2006, respectively.
Total benefits and expenditures were $1,139.5 million and $1,354.6 million for the years ended December 31, 2007 and 2006, respectively. The decrease of $215.1 million was primarily due to the following:
Interest expense - was $55.4 million and $64.4 million for the years ended December 31, 2007 and 2006 respectively. The $9.0 million decrease in interest expense was primarily due to a $13.2 million decrease related to the redemption of a $380 promissory note on May 27, 2007 and a $2.3 million decrease related to interest allocated from the Corporate Segment, offset by a $6.6 million increase related to two $100 million floating rate demand notes issued in September 19, 2006 and May 17, 2006.
Policyholder benefits - were $151.8 million and $126.1 million for the years ended December 31, 2007 and 2006, respectively. The $25.7 million increase in 2007 compared to 2006 was primarily due to a $16.8 million increase in annuity benefits paid and a $28.0 million increase in reserves, offset by a decrease of $18.7 million in death benefits paid and a decrease of $0.4 million surrender benefits paid. For the year ended December 31, 2007, additional reserves of $31.4 million were recorded as a result of loss recognition. For the year ended December 31, 2006, the loss recognition testing did not result to any additional reserves.
Operating expenses - were $143.7 million and $158.0 million for the years ended December 31, 2007 and 2006, respectively. The decrease of $14.3 million was primarily due to decrease in commission expense.
Amortization of DAC - relates to the costs of acquiring new business, which vary with and are primarily related to the production of new business. Such acquisition costs include commissions, costs of policy issuance, and underwriting and selling expenses. Amortization expense was $177.1 million and $386.5 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The amortization expense included the effect of revisions in estimated future gross profits which aggregated $(3.5) million and $150.1 million for the years ended December 31, 2007 and 2006, respectively. The most significant assumption changes for the year ended December 31, 2006 related to assumptions regarding lapses, future growth rates of capital markets assumptions and expense assumptions. Decreased actual gross profits contributed to the decrease in DAC amortization for the year ended December 31, 2007.
Amortization of VOBA - was $11.5 million and $7.6 million for the years ended December 31, 2007 and 2006, respectively. The amortization expense was increased (decreased) by an unlocking adjustment of $0.5 million and $(8.3) million for the years ended December 31, 2007 and 2006, respectively.
The following provides a summary of operations for the Individual Protection Segment for the years ended December 31 (in 000's):
Total expenses were $148.1 million and $95.8 million for the twelve-month periods ended December 31, 2007 and 2006, respectively. The $52.3 million increase was primarily due to a $34.2 million increase in other operating expenses, an $8.4 million increase in interest credited and a $12.0 million increase in interest expense, offset by a decrease of $12.4 million in DAC amortization. The change in operating expenses was primarily attributable to an increase in premium taxes of $25.3 million, as well as expenses associated with the reinsurance agreement between Sun Life Vermont and SLOC, which became effective during the fourth quarter of 2007. The reinsurance agreement between Sun Life Vermont and SLOC resulted in a $26.2 million increase in benefits and expenses for the year ended December 31, 2007. Please refer to Note 8 of the consolidated financial statements for further information on this reinsurance.
The Group Protection Segment markets and administers group life insurance, group stop loss insurance, group dental, group short-term and group long-term disability insurance products to small and mid-size employers. This segment operates only in the state of New York through the Company’s subsidiary, SLNY. Effective May 31, 2007, the Company completed the SLHIC to SLNY asset transfer and the Group Protection Segment of the Company reflects a significant increase in business as a result of these agreements. The agreements allowed the Company to expand its product offerings to include group dental insurance.
Total revenues for the year ended December 31, 2007 increased by $57.9 million as compared to the year ended December 31, 2006. Premiums assumed increased $51.0 million as a result of the SLHIC to SLNY asset transfer. The remaining increase of $6.9 million results primarily from increased in-force business in group disability, group dental, group stop loss and group life insurance, with direct premium increases of $3.6 million, $1.9 million and $1.0 million, respectively.
The Corporate Segment consists of the unallocated capital of the Company, its debt financing, and items not otherwise attributable to the other segments.
Total benefits and expenses for the year ended December 31, 2007 increased by $11.7 million in comparison to the year ended December 31, 2006. The increase was primarily due to a $25.6 million prepayment fee related to the early redemption of $600 of partnership capital securities and an $18.3 million increase in other operating expense, offset by a $32.1 million decrease in interest expense related to the early redemption of $600 million of subordinated debentures due to an affiliate during 2007. The increase in other operating expense was primarily due to increase in expense related to administrative and support services provided to the Company by its affiliates, Sun Life Information Services Canada, Inc. and Sun Life Information Services Ireland Limited, as well as an increase in salaries.
At December 31, 2007, the Company held $21.1 billion in invested assets and cash. Of this balance, $15.4 billion was invested in fixed-maturity securities designated as either available-for-sale ($11.5 billion) or trading ($3.9 billion). Of the $11.5 billion of available-for-sale fixed maturities, securities with a fair value of $7.0 billion were in an unrealized loss position totaling $511.8 million. At December 31, 2007, 77% of securities in an unrealized loss position, based on fair value, were securities with fair value to amortized cost percentages of greater than or equal to 90%. The total unrealized loss position for such securities was $193.8 million.
“Impaired List”- Management has concluded that the fair value will not increase enough to recover the Company’s amortized cost and an other-than-temporary-impairment charge is recorded to income or the security is sold and a realized loss is recorded as a charge to income. Impairments are classified as either credit-related or interest-related. The Company categorizes impairments as credit-related if there are current concerns regarding the issuers’ ability to pay all principal and interest amounts due, according to the contractual terms of the security or if the decline in fair value of the security is driven by issuer-specific credit events. The Company characterizes impairments as interest-related if the depression in fair value of the security was due to changes in interest or general credit spread widening and for which the Company has determined it no longer has the intent or ability to hold a security until recovery to amortized cost. For the year ended December 31, 2007, other-than-temporary impairments of $68.1 million were recorded as a charge to income. Of this balance, $52 million was credit-related and $16.1 million was interest-related.
If, subsequent to December 31, 2007, management were to conclude that all securities included on the Company’s Watch List were other-than-temporarily impaired, the Company’s earnings in the subsequent period, after consideration of offsetting DAC and tax effects, would decrease by approximately $2.0 million, based on the fair value of such securities as of December 31, 2007. If, subsequent to December 31, 2007, management were to conclude that all securities included on both the Company’s Watch and the Monitor Lists were other-than-temporarily impaired, then the Company’s earnings in the subsequent period, after consideration of offsetting DAC and tax effects, would decrease by approximately $4.9 million, based on the fair value of such securities as of December 31, 2007. Because the Company has not classified any of its unaffiliated fixed maturity investments as held-to-maturity, a later conclusion that Watch and Monitor List securities are other-than-temporarily impaired would not result in any change to the Company’s Total Stockholder’s Equity, but would result in a reclassification from Accumulated Other Comprehensive Income to Retained Earnings in the Stockholder’s Equity section of the Balance Sheet, due to the impact to net income described above.
The following table shows the fair value and gross unrealized losses of the Company’s available-for-sale fixed maturity investments, which were deemed to be temporarily impaired, aggregated by investment category, industry sector and length of time that the individual securities had been in an unrealized loss position at December 31, 2007.
The table below provides the detail of the six largest unrealized losses by CUSIP in the Company’s fixed maturity portfolio at December 31, 2007. Management does not consider any of these unrealized losses to be material to the Company’s financial position at December 31, 2007. Management's reasons for concluding that the fair value will increase enough to recover the Company’s amortized cost of these securities follow the table.
Issue B. The unrealized loss on Issue B is primarily due to a slow down in the issuer’s sector, the U.S. homebuilding market, as well as credit rating agency downgrades from the dates of the Company’s purchase (December 2006, February 2007, and April 2007) to December 31, 2007. This issuer is a major supplier of home building and home improvement supplies to professional contractors and homeowners and currently has an investment grade rating of Baa1/BBB+.
Issue C. The unrealized loss on Issue C is primarily due to the downturn in the mortgage and structured finance markets. There have been no defaults in the underlying credits backing this transaction, and none are expected. In addition, there is credit enhancement supporting the current investment grade ratings of AA.
Issue D. The unrealized loss on issue D is primarily due a downgrade of this security to BBB+ from A-. The issuer has been largely impacted by the weakened mortgage market, which has resulted in higher than expected provisions for losses in its investment portfolio. Continued weakness in the mortgage market and consumer lending is expected, but the issuer has a solid capital base, ample liquidity and is pursuing several initiatives to strengthen its balance sheet and reduce risk.
Issue E. The unrealized loss on issue E is primarily due to a slow down in the US housing market. At present, the domestic new home market is exceptionally weak, which has impacted the financial metrics and placed stress on the liquidity profile of this issuer. Nevertheless, the issuer maintains an adequate liquidity profile, asset protection and scale of operations and continues to perform in accordance with the contractual terms of the security. This security maintains a BBB investment grade rating.
The sales of securities in the year ended December 31, 2007, that were in an unrealized loss position were primarily due to actual liquidity needs that were different from anticipated liquidity needs. Management responded by selling certain securities that were in an unrealized gain position and by reconsidering the Company’s intent to hold certain securities that were in an unrealized loss position until recovery and selling them at a loss. The objective of these sales was to keep the portfolio optimally balanced and diversified with respect to asset mix, interest rate risk, yield, duration, and credit quality.
Net of tax benefit of $64.7 million, $25.5 million and $43.0 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Net of tax (expense) benefit of $(1.2) million, $(21.9) million and $42.9 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Sun Life Assurance Company of Canada (U.S.) (the “Company”) and its subsidiaries are engaged in the sale of individual and group variable life insurance, individual universal life insurance, individual and group fixed and variable annuities, funding agreements, group life, group disability, group dental and group stop loss insurance. These products are distributed through individual insurance agents, financial planners, insurance brokers and broker-dealers to both the tax-qualified and non-tax-qualified markets. 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.
The Company is a stock life insurance company incorporated under the laws of Delaware. The Company is a direct wholly-owned subsidiary of Sun Life of Canada (U.S.) Holdings, Inc. (the "Parent"). The Company is an indirect wholly-owned subsidiary of Sun Life Assurance Company of Canada - U.S. Operations Holdings, Inc. ("SLC - U.S. Ops Holdings") and is an indirect wholly-owned subsidiary of Sun Life Financial Inc. ("SLF"), a reporting company under the Securities Exchange Act of 1934. SLF and its subsidiaries are collectively referred to herein as "Sun Life Financial."
The consolidated financial statements include the accounts of the Company and its subsidiaries. As of December 31, 2007, the Company directly or indirectly owned all of the outstanding shares or members interest of SLNY, which issues individual fixed and variable annuity contracts, group life, group disability, group dental and stop loss insurance, and individual life insurance in New York; Independence Life and Annuity Company (“INDY”), a Rhode Island life insurance company that sold variable and whole life insurance products; Sun Life Vermont, a Vermont special purpose financial captive insurance company; Clarendon Insurance Agency, Inc., a registered broker-dealer; Sun Life of Canada (U.S.) SPE 97-I, Inc., organized for the purpose of engaging in activities incidental to securitizing mortgage loans; SLF Private Placement Investment Company I, LLC; Sun Parkaire Landing LLC; 7101 France Avenue Manager, LLC; Sun MetroNorth, LLC; and SLNY Private Placement Investment Company I, LLC.
On October 31, 2007, the Company subscribed for $250,000 worth of shares of, and contributed $150 million of paid-in capital to, a newly formed wholly-owned subsidiary, Sun Life Vermont. Effective November 8, 2007, Sun Life Vermont entered into a reinsurance agreement with Sun Life Assurance Company of Canada (“SLOC”), an affiliate of the Company, under which the Sun Life Vermont has assumed the risks of certain individual universal life insurance (“UL”) policies issued, and to be issued, by SLOC. This agreement is described more fully in Note 8. A long-term financing arrangement has been established with a financial institution (the "Lender") that will enable Sun Life Vermont to fund a portion of its obligations under the reinsurance agreement with SLOC. Under this arrangement, Sun Life Vermont issued a $1 billion variable principal, floating rate surplus note (the “Surplus Note”) to a special-purpose entity, Structured Asset Repackage Company, 2007-SUNAXXX LLC (“SUNAXXX”) affiliated with the Lender. Pursuant to an agreement between the Lender and SLC - U.S. Ops Holdings, SLC - U.S. Ops Holdings bears the ultimate obligation to repay the Lender and, as such, has consolidated SUNAXXX in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (Revised December 2003)" (“FIN 46(R)”).
Effective May 31, 2007, Sun Life Financial completed its acquisition of Genworth Financial, Inc.'s (“Genworth’s”) Employee Benefits Group business ("EBG"). Also effective May 31, 2007, SLNY entered into a series of agreements with Sun Life and Health Insurance Company (U.S.) (“SLHIC”), one of the acquired companies (formerly named Genworth Life and Health Insurance Company), through which the New York issued business of SLHIC was transferred to SLNY. These agreements include a 100% coinsurance agreement for all existing and future new business issued in New York, a renewal rights agreement under which SLNY has exclusive rights to renew in-force business assumed under the reinsurance agreement and an administrative service agreement under which SLNY has agreed to assume direct responsibility for all sales and administration of existing and new business issued in New York (collectively, “the SLHIC to SLNY asset transfer”). These agreements, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” were treated as a transfer of net assets between entities under common control. SLNY paid $40 million of total consideration to SLHIC. SLHIC transferred assets at carrying value of approximately $72 million, including $38.9 million of goodwill and other intangibles, as well as policyholder and other liabilities of approximately $32 million to SLNY. The Group Protection Segment of the Company reflects a significant increase in business as a result of these agreements. These agreements have allowed the Company to expand its product offerings to include group dental insurance.
On April 19, 2005, the Company sold its interest in a consolidated variable interest entity (“VIE”) and recognized a gain of $6.1 million. The Company received net cash proceeds of $17.0 million and reduced consolidated assets and liabilities by $74.5 million and $63.6 million, respectively. The Company’s net income for the year ended December 31, 2005 included a net loss of $0.8 million related to this VIE.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The most significant estimates are those used in determining the fair value of financial instruments, goodwill, DAC, VOBA, the liabilities for future contract and policyholder benefits and other-than-temporary impairments of investments. Actual results could differ from those estimates.
In the normal course of business, the Company enters into transactions involving various types of financial instruments, including cash equivalents, fixed maturity investments, 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 SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." At the time of purchase, fixed maturity securities are classified based on the Company's intent as either held-to-maturity, trading or available-for-sale. In order for a security to be classified as held-to-maturity, the Company must have positive intent and ability to hold the security 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. 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 held-to-maturity or trading criterion are classified as available-for-sale. Included with available-for-sale fixed maturities are mortgage backed securities in the To Be Announced ("TBA") form. 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 are carried at fair value with the unrealized gains or losses reported in other comprehensive income.
The Company determines the fair value of its publicly traded fixed maturities using four primary pricing methods: third-party pricing services, independent dealer quotes, pricing matrices, and pricing models. Prices are first sought from third party pricing services; the remaining unpriced securities are priced using one of the remaining three methods. Third-party pricing services derive the security prices through recently reported trades for identical or similar securities with adjustments for trading volumes and market observable information through the reporting date. In the event that there are no recent market trades, pricing services and brokers may use pricing matrices and models to develop a security price based on future expected cash flows discounted at an estimated market rate using collateral performance and vintages.
The Company performs a monthly analysis on the prices received from third parties to assess if the prices represent a reasonable estimate of the fair value. The process is both quantitative and qualitative and includes back testing of recent trades, review of key assumptions such as spreads, duration, credit rating, and on-going review of third-party pricing services methodologies. In the event that a more appropriate fair value is justified, the price received from a third-party pricing services is adjusted accordingly. 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.
Impairments are classified as either credit-related or interest-related. The Company categorizes impairments as credit-related if it anticipates the issuers will be unable to pay all principal and interest amounts due, according to the contractual terms of the security or if the decline in fair value of the security is driven by issuer-specific credit events. The Company characterizes impairments as interest-related if the depression in fair value of the security was due to changes in interest or general credit spread widening and for which the Company has determined it no longer has the intent or ability to hold a security until recovery to amortized cost. Once an other than temporary impairment charge has been recorded, the Company continues to review the other-than-temporarily impaired securities for additional impairment. The net realized loss is recorded in the income statement as the difference between the fair value and the amortized cost of the security.
The Company incurred realized losses totaling $68.1 million, $6.3 million and 29.7, for the years ended December 31, 2007, 2006 and 2005, respectively, for other-than-temporary impairments. Of the $68.1 million in realized losses for other-than-temporary impairments for the year ended December 31, 2007, $16.1 million was due to a change in the Company’s intent to hold the securities to recovery of fair value, up to amortized cost. The remaining $52 million of realized losses were credit-related.
Real estate investments are held for the production of income or are held for sale. Real estate investments held for the production of income are carried at the lower of cost adjusted for accumulated depreciation or fair value. Depreciation of buildings and improvements is calculated using the straight line method over the estimated useful life of the property, generally 40 to 50 years. Real estate investments held for sale are primarily acquired through foreclosure of mortgage loans. The cost of real estate that has been acquired through foreclosure is the estimated fair value less estimated costs to dispose at the time of foreclosure. Real estate investments are diversified by property type and geographic area throughout the United States.
Interest income is recorded on the accrual basis. Investments are placed in a non-accrual status when management believes that the borrower's financial condition, after giving consideration to economic and business conditions and collection efforts, is such that collection of principal and interest is doubtful. When an investment is placed in non-accrual status, all interest accrued is reversed against current period interest income. Interest accruals are resumed on such investments only when the investments have performed on a sustained basis for a reasonable period of time and when, in the judgment of management, the investments are estimated to be fully collectible as to both principal and interest.
DAC is also adjusted for amounts relating to unrealized investment gains and losses. This adjustment, net of tax, is included with unrealized investment gains or losses that are recorded in accumulated other comprehensive (loss) income. DAC was increased by $189.8 million and $6.9 million at December 31, 2007 and 2006, respectively, to reflect unrealized losses.
VOBA is also adjusted for amounts relating to unrealized investment gains and losses. This adjustment, net of tax, is included with unrealized investment gains or losses that are recorded in accumulated other comprehensive (loss) income. The Company’s VOBA was not adjusted for amounts relating to unrealized investment gains and losses for the year ended December 31, 2007. VOBA was increased by $0.5 million at December 31, 2006 to account for unrealized investment losses.
Goodwill represents the difference between the purchase price paid and the fair value of the net assets acquired in connection with the Company’s acquisitions of Keyport on November 1, 2001 and the allocation of goodwill to SLNY, based on a reinsurance agreement with SLHIC, effective May 31, 2007. Goodwill obtained in connection with the purchase of Keyport is allocated to the Wealth Management Segment. Goodwill obtained through the reinsurance agreement with SLHIC is allocated to the Group Segment in the Company’s subsidiary, SLNY. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is tested for impairment on an annual basis. The Company completed the required impairment tests of goodwill and indefinite-lived intangible assets during the second quarter of 2007 and concluded that these assets were not impaired.
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. Reserves for pension and payout annuity contracts are calculated using the best-estimate interest and decrement assumptions that were set at the time that loss recognition testing resulted in additional reserves. 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. For the year ended December 31, 2007 additional reserves of $31.4 million were recorded as a reduction to income and additional reserves of $7.5 million were recorded as a component of other comprehensive loss. Reserves for guaranteed minimum death benefits and guaranteed minimum income benefits are calculated according to the methodology of AICPA Statement of Position 03-1, "Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts" ("SOP 03-1"), whereby the expected benefits provided by the guarantees are spread over the duration of the contract in proportion to the benefit assessments.
Contractholder deposit funds consist of policy values that accrue to the holders of universal life-type contracts and investment-related products such as deferred annuities, single premium whole life policies ("SPWL"), 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.
Fees from investment advisory services are recognized as revenues when the services are provided.
For the years ended December 31, 2007, 2006 and 2005, the Company participated in a consolidated federal income tax return with SLC - U.S. Ops Holdings and other affiliates. For the years ended December 31, 2006 and 2005, the Company’s subsidiaries INDY and SLNY filed stand-alone federal income tax returns. INDY, SLNY and Sun Life Vermont, a new subsidiary, will be included as part of the consolidated federal income tax return for the year ended December 31, 2007.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140.” This statement amended SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," and resolved issues addressed in SFAS No. 133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." The Company began applying SFAS No. 155 to all financial instruments acquired, issued or subject to a remeasurement event beginning January 1, 2007. The Company elected the fair value option for $16.6 million of available-for-sale securities during the year ended December 31, 2007. The election did not have a material impact on the Company’s results of operations.
In September 2005, the American Institute of Certified Public Accountants (the "AICPA") issued Statement of Position 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts" ("SOP 05-1"). SOP 05-1 provides guidance on accounting by insurance enterprises for DAC on internal replacements of insurance and investment contracts. The adoption of SOP 05-1 on January 1, 2007 did not have a material impact on the Company’s consolidated financial condition and results of operations.
The provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007, and are to be applied prospectively, except for changes in fair value measurements that result from the initial application of SFAS No. 157, which are to be recorded as an adjustment to opening retained earnings in the year of adoption. Effective January 1, 2008, the Company adopted SFAS No. 157 and applied the provisions of the statement prospectively to assets and liabilities measured and disclosed at fair value. In addition to new disclosure requirements, the adoption of SFAS No. 157 changes the valuation of embedded derivatives associated with annuity contracts. The change in valuation of embedded derivatives associated with annuity contracts results from the incorporation of risk margins and the Company’s own credit standing in their valuation and changes to assumptions regarding policyholder lapses. The Company is currently assessing the impact of SFAS No. 157 on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). This statement replaces SFAS No. 141 and establishes the principles and requirements for how the acquirer in a business combination: (a) measures and recognizes the identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquired entity, (b) measures and recognizes positive goodwill acquired or a gain from bargain purchase (negative goodwill), and (c) determines the disclosure information that is useful to users of financial statements in evaluating the nature and financial effects of the business combination. Some of the significant changes to the existing accounting guidance on business combinations made by SFAS No. 141(R) include the following:
Acquisition-related costs incurred by the acquirer shall be expensed in the periods in which the costs are incurred rather than included in the cost of the acquired entity;
Contractual pre-acquisition contingencies are to be recognized at their acquisition date fair values and noncontractual pre-acquisition contingencies are to be recognized at their acquisition date fair values only if it is more likely than not that the contingency gives rise to an asset or liability, whereas SFAS No. 141 generally permits the deferred recognition of pre-acquisition contingencies until the recognition criteria of SFAS No. 5, “Accounting for Contingencies” are met; and
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” This statement amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (“ARB 51”). Noncontrolling interest refers to the minority interest portion of the equity of a subsidiary that is not attributable directly or indirectly to a parent. SFAS No. 160 establishes accounting and reporting standards that require for-profit entities that prepare consolidated financial statements to: (a) present noncontrolling interests as a component of equity, separate from the parent’s equity, (b) separately present the amount of consolidated net income attributable to noncontrolling interests in the income statement, (c) consistently account for changes in a parent’s ownership interests in a subsidiary in which the parent entity has a controlling financial interest as equity transactions, (d) require an entity to measure at fair value its remaining interest in a subsidiary that is deconsolidated, (e) require an entity to provide sufficient disclosures that identify and clearly distinguish between interests of the parent and interests of noncontrolling owners. SFAS No. 160 applies to all for-profit entities that prepare consolidated financial statements, and affects those for-profit entities that have outstanding noncontrolling interests in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 with earlier adoption prohibited. The Company expects to adopt SFAS No. 160 on January 1, 2009 and has not yet determined the effect of SFAS No. 160 on its consolidated financial statements.
In June 2007, the AICPA issued Statement of Position 07-1, “Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” (“SOP 07-1”). SOP 07-1 provides guidance for determining whether an entity is within the scope of the AICPA Audit and Accounting Guide Investment Companies (“the Guide”). This statement also addresses whether the specialized industry accounting principles of the Guide should be retained by a parent company in consolidation or by an investor that has the ability to exercise significant influence over the investment company and applies the equity method of accounting to its investment in the entity. In addition, SOP 07-1 includes certain disclosure requirements for parent companies and equity method investors in investment companies that retain investment company accounting in the parent company’s consolidated financial statements or the financial statements of an equity method investor. SOP 07-1 is effective for fiscal years beginning on or after December 15, 2007, with earlier application encouraged; however, in November 2007, the FASB decided to (1) delay indefinitely the effective date and (2) prohibit adoption by an entity that has not early adopted SOP 07-1. The Company did not early adopt SOP 07-1. SOP 07-1 as currently issued is not expected to have an impact on the Company’s consolidated financial condition or results of operations.
Effective September 27, 2007, the Company dissolved the General Partner. The General Partner was the sole general partner in the Partnership and, as a result, the Partnership had been consolidated with the results of the Company. The Partnership was organized to purchase subordinated debentures issued by the Parent and to issue partnership capital securities to an affiliated business trust, the Capital Trust. Effective May 6, 2007, the Parent redeemed $600 million of 8.526% subordinated debentures issued to the Partnership and paid the Partnership an early redemption premium of $25.6 million. Also effective May 6, 2007, the Partnership redeemed $600 million of the 8.526% partnership capital securities issued to the Capital Trust and paid a premium of $25.6 million to the Capital Trust. The redemption had no impact on the Company’s net income. The Partnership was cancelled effective September 27, 2007.
On September 6, 2006 the Company entered into an agreement with the CARS Trust, whereby the Company is the sole beneficiary of the trust. As of December 31, 2007 and 2006, total assets of the CARS Trust were $57.7 million and $56.6 million, respectively. As the sole beneficiary of the CARS Trust, the Company is required to consolidate this trust under the requirements of FIN 46. Accordingly, the assets and liabilities of the CARS Trust are included in the Company’s consolidated financial statements. As of December 31, 2007, the Company recorded in its consolidated balance sheets $53.8 million of trading fixed maturities, $2.9 million of deferred tax, $1.0 million of accrued investment income and $7.9 million of liabilities relating to a total return swap. As of December 31, 2006, the Company recorded in its consolidated balance sheets $55.3 million of trading fixed maturities, $1.2 million of accrued investment income and $1.7 million of liabilities.
On April 19, 2005, the Company sold its interest in a consolidated VIE and recognized a gain of $6.1 million. The Company received net cash proceeds of $17.0 million and reduced consolidated assets and liabilities by $74.5 million and $63.6 million, respectively. The Company’s net income for the year ended December 31, 2005 includes a net loss of $0.8 million related to this VIE.
The Company and its subsidiaries have administrative services agreements with SLOC which provides that SLOC will furnish, as requested, certain services and facilities on a cost-reimbursement basis. Expenses under these agreements amounted to approximately $14.2 million, $9.4 million and $11.3 million for the years ended December 31, 2007, 2006 and 2005, respectively.
The Company has an administrative service agreement with SLHIC, whereby the Company provides personnel and certain services to SLHIC, as requested. Reimbursements under this agreement, which are recorded as a reduction of other operating expenses, were $0.1 million for the year ended December 31, 2007.
Effective May 31, 2007, Sun Life Financial completed its acquisition of EBG. Also effective May 31, 2007, SLNY entered into a series of agreements with SLHIC, one of the acquired companies, through which the New York-issued business of SLHIC was transferred to SLNY. These agreements include a 100% coinsurance agreement for all existing and future new business issued in New York, a renewal rights agreement under which SLNY has exclusive rights to renew in-force business assumed under the reinsurance agreement and an administrative service agreement under which SLNY has agreed to assume direct responsibility for all sales and administration of existing and new business issued in New York. These agreements, in accordance with SFAS No. 141 were treated as a transfer of net assets between entities under common control. SLNY paid $40 million of total consideration to SLHIC. SLHIC transferred assets at carrying value of approximately $72 million, including $38.9 million of goodwill and other intangibles, as well as policyholder and other liabilities of approximately $32 million to SLNY. The Group Protection Segment of the Company reflects a significant increase in business as a result of these agreements. These agreements have allowed the Company to expand its product offerings to include group dental insurance.
In 2007, the Company recorded a tax benefit of $3.0 million through paid-in-capital for SLF stock options issued to employees of the Company. In 2006, the Company recorded a tax benefit of $4.5 million through paid-in-capital for SLF stock options issued to employees of the Company. In 2005, the Company recorded a tax benefit of $7.0 million through paid-in-capital for stock options issued to employees of the Company during 2001 through 2005. The $7.0 million tax benefit is comprised of a $2.5 million tax benefit on expenses accrued at its indirect parent, SLF, and a $4.5 million adjustment to record the excess tax benefit over the recorded book expense for stock options exercised.
In 2006, the Company declared and paid $300.0 million in a cash dividend to the Parent. In 2005, the Company declared and paid a $200.0 million dividend to the Parent, consisting of $150.6 million in cash and $49.4 million in notes. The Company did not declare or pay a dividend to the Parent in 2007.
At December 31, 2007 and 2006, the Company had $565.0 million of surplus notes issued to Sun Life Financial (U.S.) Finance, Inc. The Company expensed $42.6 million for interest on these surplus notes for each of the years ended December 31, 2007, 2006 and 2005.
The Company has an administrative services agreement with Sun Capital Advisers (“SCA”), a registered investment adviser, under which the Company provides administrative services with respect to certain open-end management investment companies for which SCA serves as the investment adviser, and which are offered to certain of the Company’s separate accounts established in connection with the variable contracts issued by the Company. Amounts received under this agreement amounted to approximately $1.9 million, $1.5 million and $2.4 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Effective December 31, 2007, SLNY entered into a reinsurance agreement with SLOC under which SLOC will fund AXXX reserves, attributable to certain UL policies sold by SLNY. Under this agreement SLNY ceded, and SLOC assumed, on a funds withheld 90% coinsurance basis certain inforce policies at December 31, 2007. Future new business also will be reinsured under this agreement. Under the agreement, SLNY ceded $63.1 million of policyholder balances, received a ceding commission of $54.2 million, recorded a funds withheld payable to SLOC of $71.6 million, and recorded a deferred gain of $45.7 million.
On October 31, 2007, the Company subscribed to $250,000 worth of shares of, and contributed $150 million of paid-in capital to, a newly formed wholly-owned subsidiary, Sun Life Vermont. Sun Life Vermont is a Vermont-domiciled captive special purpose financial insurance company which, effective November 8, 2007, has entered into a reinsurance agreement with SLOC, the Company’s affiliate, under which the Sun Life Vermont assumed, and will assume, the risks of certain UL policies issued, and to be issued, by SLOC. This agreement is described more fully in Note 8. A long-term financing arrangement has been established with the Lender that will enable Sun Life Vermont to fund a portion of its obligations under the reinsurance agreement with SLOC. Under this arrangement, on November 8, 2007, Sun Life Vermont issued a Surplus Note to a special-purpose entity, SUNAXXX, affiliated with the Lender. Pursuant to an agreement between the Lender and SLC - U.S. Ops Holdings, SLC - U.S. Ops Holdings bears the ultimate obligation to repay the Lender and, as such, will consolidate SUNAXXX in accordance with FIN 46. Sun Life Vermont has agreed to reimburse SLC - U.S. Ops Holdings for certain costs incurred in connection with the issuance of the Surplus Note. For the year ended December 31, 2007, the amount of interest expense incurred by Sun Life Vermont was $8.6 million.
On September 12, 2006, the Company entered into a Terms Agreement (the "2006-B Terms Agreement") with its affiliates Sun Life Financial Global Funding III, L.P. (the "Issuer III"), Sun Life Financial Global Funding III, U.L.C. (the "ULC III") and Sun Life Financial Global Funding III, L.L.C. (the "LLC III"), and with Citigroup Global Markets, Inc., Deutsche Bank Securities Inc., Morgan Stanley & Co. Incorporated, Banc of America Securities LLC, Credit Suisse Securities (USA) LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, RBC Capital Markets Corporation and Wachovia Capital Markets (each, an "Initial Purchaser" and collectively, the "2006-B Initial Purchasers"), in connection with the offer and sale by the Issuer III of $750 million of Series 2006-1 Floating Rate Notes due 2013 ("2006-B Notes"). On September 21, 2006, the Company entered into another Terms Agreement (together with the original 2006-B Terms Agreement, the "2006-B Terms Agreements") with the same parties as the original 2006-B Terms Agreement in connection with the offer and sale by the Issuer III of a second tranche of $150 million of 2006-B Notes. The payment obligations of the Issuer III for the full $900 million of 2006-B Notes are unconditionally guaranteed by the LLC III pursuant to a guarantee (the "2006-B Secured Guarantee") dated as of September 19, 2006, and the obligations of the LLC III under the 2006-B Secured Guarantee are secured by two floating rate funding agreements issued by the Company to the LLC III, one for $750 million issued on September 19, 2006 and another for $150 million issued on September 29, 2006. Total interest credited for the funding agreements was $51.6 million and $14.9 million for the years ended December 31, 2007 and 2006, respectively.
The Company has entered into an interest rate swap agreement with the LLC III with an aggregate notional amount of $900 million that effectively converts the floating rate payment obligations under the funding agreements to fixed rate obligations. The net interest payable under this swap agreement was $0.2 million at December 31, 2007.
Total interest credited for the funding agreements associated with the First Tranche Notes and Second Tranche Notes was $51.6 million, $49.5 million and $20.7 million for the years ended December 31, 2007, 2006 and 2005, respectively.
On June 10, 2005, the Company issued a $100 million floating rate demand note payable to the LLC. The Company expensed $5.8 million, $5.5 million and $2.3 million for interest on the demand note for the years ended December 31, 2007, 2006 and 2005, respectively.
The Company has entered into two interest rate swap agreements with the LLC with an aggregate notional amount of $900 million that effectively convert the floating rate payment obligations under the funding agreements to fixed rate obligations.
The following table lists the details of notes due to affiliates at December 31, 2007 (in 000’s):
The amortized cost and fair value of fixed maturities at December 31, 2006, was as follows:
The amortized cost and estimated fair value by maturity periods for fixed maturity investments are shown below. Actual maturities may differ from contractual maturities on asset-backed and mortgage-backed securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
As of December 31, 2007 and 2006, 96.0% and 96.5%, respectively, of the Company's fixed maturities were investment grade. Investment grade securities are those that are rated "BBB" or better by nationally recognized rating organizations. During 2007, 2006 and 2005, the Company incurred realized losses totaling $68.1 million, $6.3 million and $29.7 million, respectively, for other-than-temporary impairment of value of some of its fixed maturities.
The Company had outstanding commitments with respect to funding of limited partnerships of approximately $34.9 million and $53.3 million at December 31, 2007 and 2006, respectively.
The Company’s portfolio monitoring process is designed to identify securities that may be other-than-temporarily impaired. The Company has a Credit Committee comprised of professionals from the investment and accounting functions that meets at least quarterly to review individual issues or issuers that may be of concern. The process involves a quarterly screening of all impaired securities, with particular attention paid to identify those securities whose fair value to amortized cost percentages have been less than 80% for an extended period of time. Additionally, the Company screens all sales transactions which generated realized losses in excess of $1.5 million and 10% of amortized cost in order to identify identical securities or issuers which the Company continues to hold. Discrete credit events, such as a ratings downgrade, are also 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 condition 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. Based on this evaluation, issues or issuers are considered for inclusion on one of the Company’s following credit lists:
The Company discontinues accruing income on all of its holdings for issuers that are in default. Accrued income was not materially impacted by the termination of accrual accounting on these holdings for the year ended December 31, 2007. The termination of accrual accounting on these holdings reduced previously accrued income by $0.6 million and $1.7 million for the years ended December 31, 2006 and 2005, respectively. As of December 31, 2007 and 2006, the Company did not have any holding for issuers that were in default. As of December 31, 2005, the fair market value of holdings for issuers in default was $24.4 million.
The sales of securities in the year ended December 31, 2007, which were in an unrealized loss position at the time of sale were primarily due to actual liquidity needs that were different from anticipated liquidity needs. Management responded by selling certain securities that were in an unrealized gain position and by reconsidering the Company’s intent to hold certain securities that were in an unrealized loss position until recovery and selling them at a loss. The objective of these sales was to keep the portfolio optimally balanced and diversified with respect to asset mix, interest rate risk, yield, duration, and credit quality.
The Company invests in commercial first mortgage loans and real estate throughout the United States. Investments are diversified by property type and geographic area. Mortgage loans are collateralized by the related properties and generally are no more than 75% of the property’s value at the time that the original loan is made.
At December 31, 2007, scheduled mortgage loan maturities were as follows:
The Company has made funding commitments of mortgage loans on real estate and other loans into the future. The outstanding funding commitments for these mortgages amount to $17.8 million and $99.0 million at December 31, 2007 and 2006, respectively.
The Company is engaged in certain securities lending transactions, which require the borrower to provide collateral on a daily basis, in amounts in excess of 102% of the fair value of the applicable securities loaned. The Company retains effective control over all loaned securities and, therefore, continues to report such loaned securities as fixed maturities in its consolidated balance sheet.
Cash collateral received on securities lending transactions is reflected in other invested assets with an offsetting liability recognized in other liabilities for the obligation to return the collateral. The fair value of collateral held and included in other invested assets was $533.5 million and $895.3 million at December 31, 2007 and 2006, respectively. Fees earned on securities lending transactions were $2.2 million, $2.3 million and $1.9 million for the years ended December 31, 2007, 2006 and 2005, respectively.
The Company does not employ hedge accounting. The Company believes that its derivatives provide economic hedges and the cost of formally documenting hedge effectiveness in accordance with the provisions of SFAS No.133, “Accounting for Derivative Instruments,” is not justified. As a result, all changes in the fair value of derivatives are recorded in the current period operations as a component of derivative income.
The fair value of equity securities are based on quoted market prices. Equity securities are included as a component of other invested assets.
Derivative instruments, receivables and payables: The fair values of swaps are based on current settlement values. The current settlement values are based on dealer quotes and market prices. Fair values for options and futures are based on dealer quotes and market prices.
The Wealth Management Segment manages a closed block of single premium whole life (“SPWL”) insurance policies, a retirement-oriented tax-advantaged life insurance product. The Company discontinued sales of SPWL’s in response to certain tax law changes in the 1980s. The Company had SPWL policyholder balances of approximately $1.6 billion and $1.6 billion as of December 31, 2007 and 2006, respectively. On December 31, 2003, this entire block of business was reinsured on a funds withheld basis with SLOC, an affiliate.
Funds withheld assets comprised of trading bonds, mortgages and derivatives, amounting to $626.6 million are being held in a separate trust account for the protection of policyholders and claimants of the Branch. The assets of the trust are managed by SLOC with all of the investment returns, net of expenses, inuring to the Company. The funds withheld asset is reported in reinsurance receivable. The coinsurance treaty with funds withheld gives rise to an embedded derivative requiring that it be separated from the host reinsurance contract. The fair value of the embedded derivative at December 31, 2007 was a $3.1 million liability. The $3.1 million loss is included in net derivative income.
The Company, through its subsidiary, SLNY, has an agreement with an unrelated company whereby the unrelated company reinsures the mortality risks of the Company’s group life contracts. Under this agreement, certain group life mortality benefits are reinsured on a yearly renewable term basis. The agreement provides that the unrelated company will reinsure amounts above $0.7 million per claim for group life contracts ceded by the Company.
The Company, through its subsidiary, SLNY, has an agreement with an unrelated company whereby the unrelated company reinsures the morbidity risks of SLNY’s group long-term disability contracts. Under this agreement, certain long-term disability benefits are reinsured on a yearly renewable term basis. The agreement provides that the unrelated company will reinsure amounts in excess of $4,000 per claim per month for long-term disability contracts ceded by SLNY. The retention limit was raised to $9,000 per claim per month for claims incurred or after January 1, 2006.
Prior to 2006 the Company participated in the UBF plan which was sponsored by SLOC and expensed the portion of the plan cost that was allocated to the Company. Effective January 1, 2006 the plan was divided, with the Company taking over the benefit obligation and the associated unrecognized gain/loss and prior service cost/credit. The Company has included the allocated projected benefit obligation (“PBO”) in a separate line in the PBO reconciliation, and accounted for the plan as the Company’s own from that point forward.
a) To provide retiree medical coverage where the retiree pays the entire cost of coverage equal to the cost paid by active employees unless the participant is a retiree as of December 31, 2005, a "Grandfathered employee," or a “Rule 75 employee.”
For Grandfathered and Rule 75 employees, retiree medical coverage is provided at a reduced cost.
On September 29, 2006, the FASB issued SFAS No. 158, “Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans,” which amends SFAS No. 87 and SFAS No. 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS No. 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS No. 87 and SFAS No. 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date - the date at which the benefit obligation and plan assets are measured - is required to be the Company's fiscal year end. SFAS No. 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company adopted the balance sheet recognition provisions of SFAS No. 158 at December 31, 2006 and will adopt the year end measurement date in 2008. As of December 31, 2007, the adoption of SFAS No. 158 as not had a material impact on the Company’s financial condition or results of operations.
Amounts recognized in the Company’s Accumulated Other Comprehensive Income (“AOCI”) consist of the following:
The retirement plan and agent’s pension plan are overfunded at December 31, 2007 and 2006. The funded status of the UBF plan as of December 31, 2007 and 2006 was as follows:
The following table sets forth the components of the net periodic benefit cost and the Company’s share of net periodic benefit costs related to the retirement plan, agents’ plan, and UBF plan for the years ended December 31:
Changes in the Company’s accumulated other comprehensive income related to the retirement plan, agents’ plan, and UBF plan for the following periods:
Weighted average assumptions used to determine net benefit cost for the retirement plan, agents’ pension plan, and UBF plan were as follows:
The Company has estimated the following future benefit payments for the years 2008 through 2017:
The Company sponsors and participates in a savings account that qualifies under Section 401(k) of the Internal Revenue Code (“the 401(k) Plan”) for which substantially all employees of at least age 21 are eligible to participate at date of hire. Under the 401(k) Plan, the Company matches, up to specified amounts, the employees’ contributions to the plan.
On September 21, 2005, the Board of Directors of the Company approved amendments pertaining to the 401(k) Plan including the following.
For RIA participants who are at least age 40 on January 1, 2006 and whose age plus service on January 1, 2006 equals or exceeds 45, the Company also contributes to the RIA from January 1, 2006 through December 31, 2015, a percentage of the participant’s eligible compensation determined under the following chart based on the participant’s age and service on January 1, 2006.
The amount of the 2007 employer contributions under the 401(k) Plan sponsorship for the Company and its affiliates was $21.8 million. Amounts are allocated to affiliates based on their respective employees’ contributions. The Company’s portion of the expense was $ 16.1 million, $10.8 million and $4.6 million for the years ended December 31, 2007, 2006 and 2005, respectively. The Company’s 2005 contribution includes a $1.6 million accrued retroactive adjustment related to the January 1, 2006 amendments to the 401(k) Plan. This retroactive adjustment was funded in 2006.
The Company sponsors a post-retirement benefit plan for its employees and certain affiliates employees providing certain health, dental and life insurance benefits (“post-retirement benefits”) for retired employees and dependents (the “Retirement Plan”). 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.
On May 31, 2007, as part of Sun Life Financial’s acquisition of EBG, the Company provided prior service credit under its retiree medical plan to the transferred EBG employees not currently eligible for those benefits under the corresponding Genworth plan. Additionally, as part of the acquisition, the fair value of the liabilities assumed by the Company included the unfunded accumulated postretirement benefit obligation (“APBO”) attributable to the prior service cost associated with the transferred EBG employees. The final purchase price was adjusted at May 31, 2007 to settle the unfunded APBO undertaken by the Company.
Amounts recognized in the Company’s Consolidated Balance Sheets for the post-retirement benefit plan consist of the following:
In order to measure the post-retirement benefit obligation for 2007, the Company assumed a 9% annual rate of increase in the per capita cost of covered health care benefits. In addition, medical cost inflation is assumed to be 9.5% in 2008 and assumed to decrease gradually to 5.00% for 2013 and remain at that level thereafter. Assumed healthcare cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care cost trend rates would have the following effect:
The Company adopted FIN 48 on January 1, 2007. FIN 48 establishes a comprehensive reporting model which addresses how a business entity should recognize, measure, present and disclose uncertain tax positions that the entity has taken or plans to take on a tax return.
The Company has elected on a prospective basis, with the adoption of FIN 48, to recognize interest and penalties accrued related to UTBs in interest expense. The Company had accrued $10.8 million of gross interest as of January 1, 2007. During the year ended December 31, 2007, the Company recognized an additional $2.0 million in gross interest related to UTBs. The Company has not accrued any penalties.
The Company files federal income tax returns and income tax returns in various state and local jurisdictions. With few exceptions, the Company is no longer subject to examinations by the tax authorities in these jurisdictions for tax years before 2001. In August 2006, the IRS issued a Revenue Agent’s Report for the Company’s tax years 2001 and 2002. The Company is currently at the Appeals Division of the IRS ("Appeals") with respect to the tax years 2001 and 2002. In the first quarter of 2007, the IRS commenced an examination of the Company’s U.S. federal income tax returns for the tax years 2003 and 2004. This examination is anticipated to be completed by August 1, 2008. While the final outcome of the appeal and ongoing tax examinations is not determinable, the Company does not believe that any adjustments would be material to its financial position.
The Company makes or receives payments under certain tax sharing agreements with SLC - U.S. Ops Holdings. Under these agreements, such payments are determined based on the Company’s stand-alone taxable income (as if it were filing as a separate company) and based upon the SLC - U.S. Ops Holdings’ consolidated group’s overall taxable position. Sun Life Vermont is subject to an adjustment in the amount payable or receivable under its Tax Allocation Agreement to the extent of a subsequent change in its stand-alone taxable income. Sun Life Vermont is not required to pay SLC - U.S. Ops Holdings for changes in the consolidated federal tax liability that may result from changes in the timing of the utilization of Sun Life Vermont’s losses in the consolidated federal tax return. The Company received income tax refunds of $16.2 million and $32.0 million in 2007 and 2005, respectively, and made income tax payments of $22.7 million in 2006.
Activity in the liability for unpaid claims and claims adjustment expenses, which is related to the Company’s group life, group disability insurance, group dental and stop loss products is summarized below:
The Company regularly updates its estimates of liabilities for unpaid claims and claims adjustment expenses as new information becomes available and events occur which may impact the resolution of unsettled claims. Changes in prior estimates are recorded in results of operations in the year such changes are made.
As a result of changes in estimates of insured events in prior years, the liability for unpaid claims and claims adjustment expense decreased by $1.8 million and $1.3 million in 2007 and 2006, respectively. The favorable development experienced in both years was driven mainly by better than expected loss experience in group life.
The following roll-forward summarizes the change in reserve for the GMDBs and GMIBs for the year ended December 31, 2006:
Guaranteed minimum accumulation benefits (“GMABs”) and withdrawal benefits (“GMWBs”) are considered to be derivatives under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and are recorded at fair value through earnings. The fair value of the embedded derivatives is calculated stochastically using risk neutral scenarios over a fifty-year projection. Policyholder assumptions are based on experience studies and industry standards. The net balance of GMABs and GMWBs constituted (a liability) an asset in the amount of $(37.4) million and $8.4 million at December 31, 2007 and 2006, respectively.
Additions to VOBA and customer renewals acquired were a result of the SLHIC to SLNY asset transfer, as described in Footnote 1. VOBA transferred was $7.6 million and the value of customer renewals transferred was $16.2 million.
In the following presentation of consolidating financial statements, the term "SLUS as Parent" is used to denote the Company as a stand-alone entity, isolated from its subsidiaries and the term "Other Subs" is used to denote the Company's other subsidiaries, with the exception of SLNY. All consolidating financial statements are presented in thousands.
Effective January 1, 2006, the Company adopted a new capital allocation methodology for measurement of segment operating results to more closely align with rating agency standards. The changes impact the amount of capital and income on capital that is allocated to the Wealth Management, Individual Protection and Group Protection Segments from the Corporate Segment.
The Wealth Management Segment markets, sells and administers funding agreements, individual and group variable annuity products, individual and group fixed annuity products and other retirement benefit products. These contracts may contain any of a number of features including variable or fixed interest rates and equity index options and may be denominated in foreign currencies. The Company uses derivative instruments to manage the risks inherent in the contract options. Additionally, the Company consolidates the CARS Trust as a component of the Wealth Management Segment.
The Group Protection Segment markets, sells and administers group life, long-term disability, short-term disability, dental and stop loss insurance to small and mid-size employers in the State of New York, through the Company's subsidiary, SLNY.
At December 31, the Company and its insurance subsidiaries combined statutory capital and surplus and net income were as follows:
The Company’s and its insurance company subsidiaries’ ability to pay dividends is subject to certain statutory restrictions. Delaware, New York, Rhode Island, and Vermont have enacted laws governing the payment of dividends to stockholders by domestic insurers.
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 permitted to pay dividends up to a maximum of $179.0 million in 2008 without prior approval from the Delaware Commissioner of Insurance.
In 2007, the Company did not pay any dividends to the Parent. In 2006, the Company’s board of directors approved and the Company paid a $300.0 million dividend to the Parent. In 2005, the Company’s board of directors approved and the Company paid a $200.0 million dividend to the Parent, consisting of $150.6 million in cash and $49.4 million in notes.
New York law permits a domestic stock life insurance company to distribute a dividend to its shareholders without prior notice to the New York Superintendent of Insurance, where the aggregate amount of such dividends in any calendar year does not exceed the lesser of: (i) ten percent of its surplus to policyholders as of the immediately preceding calendar year; or (ii) its net gain from operations for the immediately preceding calendar year, not including realized capital gains. SLNY is permitted to pay dividends up to a maximum of $20.7 million in 2008 without prior approval from the New York Commissioner of Insurance. No dividends were paid by SLNY during 2007, 2006 or 2005.
Rhode Island law requires prior regulatory approval for any dividend where the amount of such dividend paid during the preceding twelve-month period would exceed the lesser of (i) ten percent of the insurance company’s surplus as of the December 31 next preceding, or (ii) its net gain from operations, not including realized capital gains, for the immediately preceding calendar year, excluding pro rata distributions of any class of the insurance company’s own securities. INDY is permitted to pay dividends up to a maximum of $2.3 million in 2008 without prior approval from the Rhode Island Commissioner of Insurance. .No dividends were paid by INDY during 2007, 2006 or 2005.
The components of accumulated other comprehensive (loss) income as of December 31 were as follows:
The Company is not aware of any contingent liabilities arising from litigation or other matters that could have a material effect upon the financial condition, results of operations or cash flows of the Company.
In the normal course of its business, the Company has entered into agreements that include indemnities in favor of third parties, such as contracts with advisors and consultants, outsourcing agreements, underwriting and agency agreements, information technology agreements, distribution agreements, and service agreements. The Company has also agreed to indemnify its directors and certain of its officers and employees in accordance with the Company’s by-laws. The Company believes any potential liability under these agreements is neither probable nor estimatable. Therefore, the Company has not recorded any associated liability.
We have audited the accompanying consolidated balance sheets of Sun Life Assurance Company of Canada (U.S.) and subsidiaries (the "Company") as of December 31, 2007 and 2006, 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, 2007. 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, effective January 1, 2007, the Company adopted the provisions of the Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No.109”.