The Company's home office consists of four office buildings located in Wellesley Hills, Massachusetts. The Company owns this facility and leases it to SLOC for lease terms not exceeding five years. During 2001, the operations of the Company's Wealth Management segment were moved to the home office in Wellesley Hills. Prior to May 2001, the Wealth Management operations were primarily conducted from office space in Boston, Massachusetts, which was leased by the Company from unrelated parties. The home office of SLNY consists of office space in New York, New York, and is leased from an unrelated party.
The Company also leases office space in Lincoln, Rhode Island from an unrelated party. In 2004, the Company announced its intentions to relocate the Lincoln, Rhode Island operations to Wellesley Hills commencing July 1, 2004. The Company also leases property in Boston, Massachusetts that was formerly occupied by Keyport personnel. The Company is in the process of subleasing this property.
The Private Securities Litigation Reform Act of 1995 defines forward-looking statements as statements not based on historical fact and provides a safe harbor for such statements. This discussion includes forward-looking statements by the Company. These statements relate to such topics as volume growth, market share, and financial goals. It is important to understand that these forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those that the statements anticipate. These risks and uncertainties may concern, among other things:
The consolidated financial statements are prepared in accordance with GAAP, which require the Company to make estimates and assumptions. The Company believes that of its significant accounting policies, the following may involve a higher degree of judgement and complexity.
Acquisition costs related to the issuance of fixed and variable annuities and life insurance products are deferred and amortized, generally in proportion to the ratio of annual gross profits to the estimated total gross profits over the lives of the contracts. Estimated gross profits are reviewed quarterly and adjusted retrospectively when the Company revises its estimates. Estimated gross profits include assumptions related to investment yields and interest rates, mortality, lapse, expense, and asset growth rates. Although realization of deferred policy acquisition costs ("DAC") is not assured, the Company believes that all of these costs will be realized. The amount of DAC considered realizable, however, could be reduced if the estimates of gross profits or total revenues discussed above are reduced.
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. These changes in assumptions resulted in a (decrease) increase in DAC amortization of $(37.4) million and $95.1 million for the years ended December 31, 2003 and 2002, respectively.
DAC is also adjusted for amounts relating to the recognition of unrealized investment gains and losses. This adjustment, net of tax, is included with the change in net unrealized investment gains or losses that is credited or charged directly to accumulated other comprehensive income (loss). DAC was decreased by $(79.2) million and $(39.9) million at December 31, 2003 and 2002, respectively, relating to this adjustment.
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 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.
Fixed Annuities - Fixed annuity products are principally single premium deferred annuities ("SPDA"). A SPDA policyholder typically makes a single premium payment at the time of issuance. The Company obligates itself to credit interest to the policyholder's account at a rate that is guaranteed for an initial term (typically one year) and is reset annually thereafter, subject to a guaranteed minimum rate. Interest crediting continues until the policy is surrendered, the policyholder dies, or when the policyholder turns age 90.
Variable Annuities - Variable annuities offer a selection of underlying investment alternatives that may satisfy a variety of policyholder risk/return objectives. Under a variable annuity, the policyholder has the opportunity to select separate account investment options (consisting of underlying mutual funds), which pass the investment risk directly to the policyholder in return for the potential of higher returns. Variable annuities also include guaranteed fixed interest options. The Company has several different variable annuity products that currently offer various separate account investment choices, depending on the product, and guaranteed fixed interest options.
While the Wealth Management segment currently does not offer traditional life insurance products, it manages a closed block of single premium whole life insurance policies ("SPWL"), 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 $1.7 billion as of December 31, 2003. On December 31, 2003, this entire block of business was reinsured with SLOC, an affiliated company.
The Company sells its annuity products via two affiliated wholesale distribution organizations, MFSLF and Independent Financial Marketing Group, Inc. ("IFMG"). The annuity products are also distributed through a variety of unaffiliated retail organizations including securities brokers, financial institutions, insurance agents, and financial advisers. Investment funds available under these products are managed by several investment managers, including MFS, an affiliate of the Company, and SCA, a subsidiary of the Company.
The Wealth Management Segment has been significantly impacted by changes in the financial markets. The pre-tax income of $162.0 million for the year ended December 31, 2003 was $294.6 million greater than the $132.6 million pre-tax loss for the year ended December 31, 2002. The increase in income over 2002 was primarily due to improvements in realized gains coupled with a reduction of operating and DAC expenses
Total Revenues were $1,409.6 million and $1,273.4 million for the years ended December 31, 2003 and 2002, respectively. The increase of $136.2 million was primarily due to the increase in realized gains on the sale of securities. The significant changes from the prior year were as follows:
Investment income - was $1,168.8 million and $1,182.1 million for the years ended December 31, 2003 and 2002, respectively. Investment income, excluding the mark to market of the trading portfolio and partnership income, was $1,059.3 million and $1,139.8 million for the years ended December 31, 2003 and 2002, respectively. The decrease of $80.5 million during 2003, as compared to 2002, was the result of a slightly lower average investment yield ($88.5 million), and an increase in average invested assets ($8.0 million). Changes in the market value of securities in the trading portfolio resulted in an increase in investment income of $63.6 million for the year ended December 31, 2003, as compared to the same period in 2002.
Separate Account fees - are primarily mortality and expense charges earned on variable annuity balances. These charges, which are based on the market values of the assets in the separate accounts supporting the contracts, were $192.0 million and $208.9 million for the years ended December 31, 2003 and 2002, respectively. Variable product fees represented 1.39% and 1.42% of the average variable annuity separate account balances for the years ended December 31, 2003 and 2002, respectively. The decrease in separate account income was due to a decrease in average separate account assets. Average separate account assets were $13.8 billion and $14.7 billion for the years ended December 31, 2003 and 2002, respectively.
Other fee income decreased from 2002 to 2003 by $7.6 million due to the sale of MFSLF in 2002.
As a component of its investment strategy and to reduce its exposure to interest rate risk, the Company utilizes interest rate swap agreements. Interest rate swap agreements are agreements to exchange with a counterparty interest rate payments of differing character (e.g., fixed-rate payments exchanged for variable-rate payments) based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company also utilizes put options on the S&P 500 Index to hedge against stock market exposure inherent in the mortality and expense risk charges and guaranteed minimum death benefit features of the Company's variable annuities.
Total benefits and expenditures were $1,247.7 million and $1,406.0 million for the years ended December 31, 2003 and 2002, respectively. The decrease of $158.3 million was primarily due to the following: Interest credited -
The Company currently markets variable life insurance products. These products include variable universal life ("VUL") products marketed to individuals and the COLI and bank-owned life insurance ("BOLI") markets. 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. Additionally, the Company also administers closed blocks of single premium whole life, universal life and variable life insurance business.
Pretax earnings from the Individual Protection Segment decreased by $5.1 million in 2003, as compared to 2002 due primarily to increased death claims. The Individual Protection Segment experienced a net loss of $2.3 million for the year ended December 31, 2003, and net income of $0.5 million for the year ended December 31, 2002. During 2003, the Company received $218.5 million of deposits, which was $762.1 lower than 2002 deposits. The decrease in deposits resulted in a decrease in fee income of approximately $13.4 million. This decrease occurred primarily in the BOLI line, which had a decrease in fee income of $10.2 million. The decrease in fee income was offset by a decrease in operating expenses of $10.9 million. The change in operating expenses consisted of reduced premium taxes of $14.8 million due to the lower deposits as compared to 2002, increased asset management fees of $2.6 million and higher expenses with the VUL product of $1.1 million due to increased distribution and allocated expenses.
Mortality expenses for the year ended December 31, 2003 increased by $4.6 million as compared to the year ended December 31, 2002. The increased mortality expenses were primarily in the closed block universal life and variable life products. Additionally, DAC amortization expense for the year ended December 31, 2003 was $2.0 million lower than the year ended December 31, 2002 due to favorable revisions to estimated future gross profits.
Pretax net income from the Group Protection Segment decreased by $3.7 million for the year ended December 31, 2003, as compared to 2002 due primarily to increased health and mortality benefits, and an increase in reserves in long-term disability insurance.
Total expenditures in 2003 increased by $10.1 million in comparison to 2002. The expense increase was due in part to higher commission payments of $1.5 million due to an increase in premiums and higher operating expenses of $0.8 million due to the increased volume of business. Incurred claims increased by $7.4 million primarily due to the growing insurance block of business, particularly stop loss, and a deterioration in long-term disability experience.
The Corporate Segment had a pre-tax net loss of $27.7 million for the year ended December 31, 2003, compared to pre-tax net income of $27.5 million for the year ended December 31, 2002. The $55.2 million pre-tax decrease was primarily due to $36.0 million of derivative income (related to put options) earned during the year ended December 31, 2002 that was not present in 2003. These put options were purchased as a hedge relating to the risks associated with the impact of the equity market decline on the variable annuity products. Effective July 1, 2002, the puts were reallocated to the Wealth Management Segment to better reflect the economics of the put purchase and the results of the Wealth Management Segment. Expenditures increased by $28.0 million in 2003 due to lower allocation of interest expense to the other operating Segments. A cumulative effect of change in accounting principle, net of tax, also reduced income by $7.5 million in this segment. This was due to the consolidation of two variable interest entities, Structured Enhanced Return Vehicle Trust Securities Series 2000-2 ("SERVES 2000-2") and Structured Enhanced Return Vehicle Trust Securities Series 1999-1 ("SERVES 1999-1"), required by Financial Accounting Standards Board ("FASB") Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." Additionally, there was a decrease in operating expenses of $5.1 million as compared to 2002 due to cost containment.
For a more detailed discussion of the Company's interest rate risk management policies, practices and procedures, see "Interest rate risk management" in the "Quantitative and Qualitative Disclosures about Market Risk" section below (Item 7A).
The composition of the investments in the Company's general account portfolio at December 31, were as follows (in 000's):
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 mortgage-backed and asset-backed securities. Asset-backed securities include structured equipment and receivables investments.
The Basic Industry sector is composed of the chemicals, metals, paper and forest products industries. Broadly, these industries 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. Some sub-sectors have seen recent strength in commodity pricing, which has coincided with the improving economy. In 2003, the metals sub-sector has most enjoyed the benefits of pricing gains while papers and chemicals have lagged. With oil and gas prices continuing to hover near recent record levels, chemical companies could suffer from higher raw material prices going forward. Many paper and forest product companies are under pressure to reduce debt levels. A more robust economy is expected to help most industry participants, though spreads for many issuers may have already factored in the anticipated economic rebound. The Company's portfolio is generally comprised of companies with specialty niches or dominant industry positions that may allow them to withstand market weakness and avoid significant market-value deterioration.
The Communications sector is made up of media-cable, media-non cable, telecom-wireless, and telecom-wireline. After a difficult 2002, especially in telecommunications, the sector rebounded in 2003 in terms of operating performance, credit quality, ratings and bond prices. Indeed, these four sub-sectors were among the best performing corporate sectors in 2003. The Company's overall strategy has been to overweight companies with stronger balance sheets and higher levels of free cash flow, such as: the regional Bell operating companies and rural local exchange carriers; wireless companies with better competitive positions; diversified telecommunication and media companies; and the expanding and more recession-resistant cable sector. Although the telecommunications sub-sector remains subject to negative operating trends resulting from increased competition and technological substitution, and certain companies have begun to place more emphasis on actions that could benefit shareholders at the expense of bondholders, the Company believes that credit quality should be relatively stable due to strong free cash flows, further boosted by anticipated improvements in the economy. The Company presently intends to hold stressed but performing investments in this sector through recovery.
The Finance sector encompasses banks, independent and noncaptive finance companies, insurance companies, broker-dealers and real estate investment trusts ("REITs"). With few exceptions, bonds in this broad sector continued to perform well in the fourth quarter of 2003. Bank earnings were stronger, mostly owing to continued strong consumer loan demand, lower provisioning for credit losses and increased investment banking activities. In addition, net interest margins stabilized, reversing its negative trend over several prior quarters. Credit quality measures - delinquencies, non-performing assets and charge-offs - also had another strong quarter in both the commercial and consumer sectors. Finance companies continued to be positively impacted by the low interest rate environment and improved credit quality. Broker-dealers posted a strong fourth quarter, as revenues from fixed income trading/sales remained healthy, while equity trading/sales benefited from an improved stock market. Broker-dealers also reported increased mergers and acquisitions activity and continued to keep costs under control. Life insurers posted improved earnings as the industry benefited from lower investment losses and improvement in the equity markets, which resulted in increased assets under management and improved variable product sales. However, life insurance companies continue to face challenges due to the low interest rate environment. Property and Casualty insurers reported strong results from a positive pricing environment in both personal and commercial lines and from low catastrophe experience in the fourth quarter. REIT performance has been strong due to the defensive nature of the underlying assets as well as, conservative credit covenants and policies.
The Transportation sector includes airlines, railroads, trucking and shipping companies. After a couple of years of weak operating performance, the airline sub-sector rebounded in 2003. Market sentiment improved dramatically throughout the year as increased traffic combined with stronger liquidity profiles at most of the major airlines. Also, the Chapter 11 risk for the major non-bankrupt carriers, including American Airlines, waned in 2003, which gave a vote of confidence for the industry. Despite the vast improvement in airline operating performance, the industry remains challenged by low cost carriers, overcapacity and high operating costs. The Company generally lends to the airline industry on a secured basis. Thus, recovery values are based on the supporting collateral. The Company continues to work towards recovery of stressed investments in the airline sub-sector and its analysis indicates that current carrying values are adequately supported by recovery prospects.
The Utilities sector includes regulated electric and gas utilities, regulated interstate pipelines, merchant energy companies and independent power projects. Lingering issues from the California energy crisis, the late 2001 Enron bankruptcy, Federal Energy Regulatory Commission and SEC investigations, accounting restatements, accounting rule changes and shareholder litigation continue to impact credit quality in the sector, although less so than in 2002. In 2003, there were a number of bankruptcy filings by sector participants. However, recovery rates in these bankruptcies was unusually high, reflecting strong underlying asset values in the sector. In addition, certain high profile refinancings improved sector liquidity and, in general, prices of power sub-sector bonds also improved. The Company's portfolio is diversified to include many regulated utilities, interstate pipelines and utility holding companies. In cases where the portfolio's utility holdings have been negatively impacted, ongoing analysis of both firm-specific asset values and projected industry economics continue to support the Company's holdings in this sector. The Company expects the sector to benefit in the intermediate term from a continued focus on balance sheet repair, including reduced capital expenditure, reduced dividends, asset sales and equity issuance. Progress in sector restructuring supports the Company's present intention to hold its positions until maturity or recovery.
: The asset-backed securities ("ABS") and mortgage-backed securities ("MBS") sector is comprised of structured finance securities backed by pools of loans or other obligations. The underlying loans, which may include residential mortgage loans, automobile loans, credit card loans, aircraft leases, and other obligations are generally grouped by loan purpose for securitization. For example, a single ABS could be backed by automobile loans, while another could be backed by credit card loans. Collateral debt obligations ("CDOs") are a separate type of ABS generally backed by pools of investment-grade corporate, high yield, bank loan or asset-backed securities in cash or synthetic form. Due to subordination, overcollateralization, and other credit enhancements, senior ABS usually have an investment-grade rating, and are often rated AAA. However, the level of credit enhancement may deteriorate over time as a result of loan delinquencies and defaults within the structure. The majority of the Company's write-downs in this sector in 2003 were due to ABS backed by franchise loans and aircraft leases, where the level of subordination was insufficient to protect against a severe decline in the value of the underlying collateral. Several CDO holdings also contributed to write-downs as defaults on securities backing the CDOs were higher than originally estimated, causing the value of the CDOs to drop. The Company continues to actively manage these securities. The Company's analysis indicates that carrying values of stressed ABS and CDO holdings are supported by underlying collateral valuations.
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 that has been below 80% of amortized cost for more than six months 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 and overall industry and market conditions. Any deterioration in operating performance is assessed relative to the impact on issuer financial ratios, including leverage and coverage measures specific to an industry and relative to any investment covenants. The Company's analysis also 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 Company has a Credit Committee that includes members from its Investment, Finance and Actuarial functions. The Credit Committee meets and reviews the results of the Company's impairment analysis on a quarterly basis.
The fair value of fixed maturity securities with unrealized losses by maturity date were as follows (in 000's):
Income (loss) before income tax expense (benefit) and cumulative effect of change in accounting principles
Sun Life Assurance Company of Canada (U.S.) ("SLUS") was incorporated in 1970 as a life insurance company domiciled in the State of Delaware. On April 3, 2003, SLUS and its affiliate Keyport Life Insurance Company ("Keyport"), filed a Form D (Prior notice of Transaction) with the Division of Insurance Department of Business Regulation of the State of Rhode Island and filed similar documents with the Delaware Department of Insurance. Both filings sought regulatory approval for the merger of Keyport with and into SLUS. On December 31, 2003 at 5:00 p.m., SLUS and Keyport completed the merger. Pursuant to the Merger Agreement, Keyport merged with and into SLUS with SLUS as the surviving company ("the Company"). The Company is licensed and authorized to write all business that was previously written by Keyport and SLUS. The merger has no effect on the existing rights and benefits of policyholders or contractholders from either company. Both Keyport and SLUS were direct wholly-owned subsidiaries of Sun Life of Canada (U.S.) Holdings, Inc. ("SLC U.S. Holdings"), and indirect wholly-owned subsidiaries of Sun Life Financial Inc. ("SLF"), a reporting company under the Securities Exchange Act of 1934.
The following summarizes the results of operations and total assets as of and for the year ended December 31, 2003:
The Company is a wholly-owned subsidiary of SLC (U.S.) Holdings, which is an indirect wholly-owned subsidiary of Sun Life Assurance Company of Canada ("SLOC"). SLOC is a life insurance company domiciled in Canada, which reorganized from a mutual life insurance company to a stock life insurance company on March 22, 2000. As a result of the demutualization, a new holding company, SLF, is now the ultimate parent of SLOC and the Company.
In the normal course of business, the Company enters into transactions involving various types of financial instruments, including cash and cash equivalents, fixed maturity investments, mortgage loans, equity securities, off balance sheet 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.
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.
Mortgage loans are stated at unpaid principal balances, net of provisions for estimated losses. Mortgage loans acquired at a premium or discount are carried at amortized values net of provisions for estimated losses. Mortgage loans, which include primarily commercial first mortgages, are diversified by property type and geographic area throughout the United States. Mortgage loans are collateralized by the related properties and generally are no more than 75% of the properties' value at the time that the original loan is made.
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 previously accrued is reversed against current period interest income. Interest accruals are resumed on such investments only when they are brought fully current with respect to principal and interest, 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 for each product is reviewed to determine if it is recoverable from future income, including investment income. If such costs are determined to be unrecoverable, they are expensed at the time of determination. Although realization of DAC is not assured, the Company believes it is more likely than not that all of these costs will be realized. The amount of DAC considered realizable, however, could be reduced in the near term if the estimates of gross profits or total revenues discussed above are reduced.
DAC is also adjusted for amounts relating to the recognition of unrealized investment gains and losses. This adjustment, net of tax, is included with the change in net unrealized investment gains or losses that is credited or charged directly to accumulated other comprehensive income (loss). DAC adjustments were $(79.2) million and $(39.9) million at December 31, 2003 and 2002, respectively.
VOBA represents the actuarially-determined present value of projected future gross profits from policies in force at the date of their acquisition. This amount is amortized in proportion to the projected emergence of profits. Interest is accrued on the unamortized balance at the average interest crediting rate.
VOBA is also adjusted for amounts relating to the recognition of unrealized investment gains and losses. This adjustment, net of tax, is included with the change in net unrealized investment gains or losses that is credited or charged directly to accumulated other comprehensive income (loss). VOBA adjustments were $(27.5) million and $(32.9) million at December 31, 2003 and 2002, respectively.
Goodwill represents the difference between the purchase price paid and the fair value of the net assets acquired in connection with the acquisition of Keyport on October 31, 2001 by SLC (U.S.) Holdings. Goodwill is accounted for in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." Effective January 1, 2002, goodwill is no longer amortized and 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 2003 and concluded that these assets are not impaired. The Company used the actuarial appraisal method, with assumptions and discount rates reflective of current market conditions and determined that the fair value of the Company was at least equal to the carrying value. The Company also compared the results of that valuation to a range of values based on historical multiples, and found them to be consistent with the results of the actuarial appraisal method. Goodwill is allocated to the Company's Wealth Management Segment.
Intangible assets acquired primarily consist of state insurance licenses ($10.1 million) that are not subject to amortization. The remaining $2.0 million of intangible assets relate to product rights that have a weighted-average useful life of 7 years.
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 and GICS. The liabilities consist of deposits received plus interest credited, less accumulated policyholder charges, assessments and withdrawals. The liability is before the deduction of any applicable surrender charges.
Premiums for traditional individual life products are considered revenue when due. Premiums related to group life, stop loss and group disability insurance are recognized as revenue pro-rata over the contract period. The unexpired portion of these premiums is recorded as unearned premiums. Revenue from universal life-type products and investment-related products includes charges for the cost of insurance (mortality), initiation and administration of the policy and surrender charges. Revenue is recognized when the charges are assessed except that any portion of an assessment that relates to services to be provided in future years is deferred and recognized over the period during which the services are provided.
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, expenses include interest credited to policyholders' accounts and death benefits in excess of account values, which are recognized as incurred.
The Company has established separate accounts applicable to various classes of contracts providing for variable benefits. Separate account assets are subject to general account claims only to the extent the value of such assets exceeds the separate account liabilities. Contracts for which funds are invested in separate accounts include variable life insurance and individual and group qualified and non-qualified variable annuity contracts. Investment income and changes in mutual fund asset values are allocated to policyholders; and therefore do not affect the operating results of the Company. Assets held in the separate accounts are carried at fair value and the investment risk of such securities is retained by the contractholder. The Company earns separate account fees for providing administrative services and bearing the mortality risks related to these contracts.
Certain amounts in the prior years' financial statements have been reclassified to conform to the 2003 presentation.
Effective December 31, 2003, the Company adopted the disclosure requirements of Emerging Issues Task Force ("EITF") Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments". Under the consensus, disclosures are required for unrealized losses on fixed maturity and equity securities accounted for under SFAS No. 115, "Accounting for Certain Investment in Debt and Equity Securities," that are classified as either available-for-sale or held-to-maturity.
The disclosure requirements include quantitative information regarding the aggregate amount of unrealized losses and the associated fair value of the investments in an unrealized loss position, segregated into time periods for which the investments have been in an unrealized loss position. The consensus also requires certain qualitative disclosures about the unrealized holdings in order to provide additional information that the Company considered in concluding that the unrealized losses were not other-than-temporary. For further discussion, see disclosures in Note 4.
In June 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 is intended to result in more consistent reporting of contracts as either freestanding derivative instruments subject to SFAS No. 133 in its entirety, or as hybrid instruments with debt host contracts and embedded derivative features. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on the Company's financial position or results of operations.
In April 2003, the FASB issued guidance in Statement 133 Implementation Issue No. B36, "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor of Those Instruments" ("DIG B36"), that addresses the instances in which bifurcation of an instrument into a debt host contract and an embedded derivative is required. The effective date of DIG B36 was October 1, 2003. The adoption of DIG B36 did not have a material effect on the Company's financial position or results of operations.
In November 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. Adoption of FIN No. 45 did not have a material impact on the Company.
The Company applied SFAS No. 133, as amended by SFAS No. 137 and SFAS No. 138, on January 1, 2001. As a result, the Company recorded as a change in accounting principle in the accompanying consolidated statements of income, a cumulative transition adjustment of $5.2 million, net of tax, that increased earnings relating to embedded derivatives. Prior to the adoption of SFAS No. 133, the Company had been recognizing changes in fair value of derivatives in earnings; however, embedded derivatives in insurance contracts had not been accounted for separately.
On November 18, 2003, the Company sold its interest in its' wholly-owned subsidiary, Vision Financial Corporation ("Vision"), for $1.5 million. A loss of approximately $1.0 million was realized on this transaction.
On April 1, 2003, Sun Life Financial Services Limited ("SLFSL"), a wholly-owned subsidiary of the Company, ceased operations and SLFSL was liquidated during the fourth quarter of 2003. SLFSL served as marketing administrator for the distribution of offshore products offered by SLOC, an affiliate.
On October 31, 2001, SLC (U.S.) Holdings acquired Keyport and its subsidiaries for approximately $1.7 billion in cash. As part of the acquisition, Sun Life Financial (U.S.) Holdings, Inc. ("SLF (U.S.) Holdings"), another indirect subsidiary of SLOC, acquired Independent Financial Marketing Group, Inc. ("IFMG"). The acquisition of Keyport and IFMG complemented SLF's product array and distribution capabilities and advanced SLF toward its strategic goal of reaching a top ten position in certain target product markets in North America.
This acquisition was accounted for using the purchase method under SFAS No. 141, "Business Combinations." Under the purchase method of accounting, the assets acquired and liabilities assumed are recorded at estimated fair value on the date of acquisition. The following summarizes the estimated fair values of the assets acquired and the liabilities assumed as of November 1, 2001:
In 2002, the Company completed its valuation of certain assets acquired and liabilities assumed. The revisions decreased goodwill by $9.6 million, increased the deferred tax assets by $54.9 million, increased policy liabilities by $13.0 million, increased other liabilities by $13.7 million and reduced investments and other assets by $12.8 million and $5.8 million, respectively.
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, SLF (U.S.) 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. Total net income of SLD for the years ended December 31, 2002 and 2001 was $4.9 million and $10.2 million, respectively.
On October 9, 2002, SLNY, a wholly-owned subsidiary of the Company, and Keyport Benefit Life Insurance Company ("KBL"), which was a wholly-owned subsidiary of Keyport, filed an Agreement and Plan of Merger ("Merger Agreement") with the New York State Insurance Department. On December 31, 2002 at 5:00 p.m., SLNY and KBL completed the merger. Pursuant to the Merger Agreement, KBL merged with and into SLNY, with SLNY as the surviving entity. The merger had no effect on the existing rights and benefits of policyholders or contract holders from either company. Keyport, KBL, the Company, and SLNY are, and at all times relevant to the merger were, indirectly wholly-owned subsidiaries of SLOC.
In 2003, the Company sold a $100 million note from MFS, an affiliate, to another affiliate, Sun Life (Hungary) Group Financing Limited Liability Company ("Sun Life (Hungary) LLC"), for approximately $109.1 million. The note was included in fixed maturities available-for-sale at December 31, 2002. The note was sold at a gain of $9.1 million.
The Company and its subsidiaries have management services agreements with SLOC which provide that SLOC will furnish, as requested, certain services and facilities on a cost-reimbursement basis. Expenses under these agreements amounted to approximately $73.3 million in 2003, $64.4 million in 2002, and $42.9 million in 2001.
The Company has an administrative services agreement with Sun Life Assurance Company of Canada - U.S. Operations Holdings, Inc., under which the Company provides administrative and investor services with respect to certain open-end management investment companies for which MFS serves as the investment adviser, and which are offered to certain of the Company's separate accounts established in connection with the variable annuity contracts issued by the Company. Amounts received under this agreement amounted to approximately $21.3 million, $24.0 million and $13.8 million for the years ended December 31, 2003, 2002 and 2001, respectively.
As more fully described in Note 7, the Company has been involved in several reinsurance transactions with SLOC.
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.
At December 31, 2003 and 2002, the Company had $565 million of surplus notes issued to Sun Life Financial (U.S.) Finance, Inc., an affiliate of the Company. The Company expensed $43.3 million for interest on these surplus notes for each of the years ended December 31, 2003, 2002 and 2001, respectively.
The following table lists the details of notes due to affiliates at December 31, 2003 (in 000's):
Fixed maturities with an amortized cost of approximately $18.6 million and $18.6 million at December 31, 2003 and 2002, respectively, were on deposit with federal and state governmental authorities as required by law.
As of December 31, 2003 and 2002, 93.7% and 95.1%, 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 agencies. During 2003, 2002 and 2001, the Company incurred realized losses totaling $58.1 million, $94.4 million and $5.5 million, respectively, for other-than-temporary impairment of value of some of its fixed maturities after determining that not all of the unrealized losses were temporary in nature.
During 2003, 2002 and 2001, $6.6 million, $1.6 million and $9.7 million, respectively, of the losses recorded in prior years were recovered through dispositions and are included in realized gains. The Company has stopped accruing income on several of its holdings for issuers that are in default. The termination of accrual accounting on these holdings reduced income by $10.1 million, $2.5 million and $0.4 million during 2003, 2002 and 2001, respectively.
The following table provides the fair value and gross unrealized losses of the Company's investments, which were deemed to be temporarily impaired, aggregated by investment category and length of time that individual securities have been in an unrealized loss position, at December 31, 2003:
The Company's analysis also 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 Company has a Credit Committee that includes members from the Investment, Finance and Actuarial functions. The committee meets and reviews the results of the Company's impairment analysis on a quarterly basis.
The following table provides the number of securities with gross unrealized losses, which were deemed to be temporarily impaired, at December 31, 2003 (not in thousands):
The Company monitors the condition of the mortgage loans in its portfolio. In those cases where mortgages have been restructured, values are impaired or values are impaired but mortgages are performing, appropriate allowances for losses have been made. The Company has restructured mortgage loans, impaired mortgage loans and impaired but performing mortgage loans totaling $19.5 million and $9.0 million at December 31, 2003 and 2002, respectively, against which there are allowances for losses of $6.4 million and $7.1 million, respectively. The investment valuation allowances were as follows:
INVESTMENTS (CONTINUED) At December 31, 2003, scheduled mortgage loan maturities were as follows:
During 2003 and 2002, the Company sold commercial mortgage loans in securitization transactions. The Company did not sell any commercial mortgage loans in securitization transactions during 2001. The mortgages were sold to qualified special purpose entities that were established for the purpose of purchasing the assets and issuing trust certificates. In these transactions, the Company retained investment tranches as well as servicing rights, which are considered available for sale securities. The securitizations are structured so that investors 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 pretax gains of $24.6 million and $4.5 million for its 2003 and 2002 securitization transactions, respectively.
The outstanding principal amount of the securitized commercial mortgage loans was $435.3 million at December 31, 2003, none of which were 60 days or more past due. There were no net credit losses incurred relating to the securitized commercial mortgage loans at the dates of securitization and at December 31, 2003.
Key economic assumptions and the sensitivity of the current fair value of cash flows in those assumptions at December 31, 2002 were as follows:
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 in this VIE 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 is 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. Leveraged leases are included as a part of other invested assets. The Company's net investment in leveraged leases is composed of the following elements:
The Company utilizes put options on the S&P 500 Index to hedge against stock market exposure inherent in the mortality and expense risk charges and guaranteed minimum death benefit features of the Company's variable annuities. The Company also purchases call options on the S&P 500 Index to economically hedge its obligation under certain fixed annuity contracts. Options are carried at fair value and are included with other invested assets in the accompanying balance sheet.
From the second quarter in 2000 until the second quarter in 2002, the Company marketed GICS to unrelated third parties. Each deal is highly-individualized but typically involves the issuance of foreign currency denominated contracts backed by cross currency swaps or equity-linked cross currency swaps. The combination of these swaps with interest rate swaps allows the Company to lock in U.S. dollar fixed rate payments for the life of the contract.
Change in fair value of swap agreements (interest rate,currency, and equity)
The Company's underlying notional or principal amounts associated with open derivatives positions were as follows:
Net realized investment gains (losses) consisted of the following for the years ended December 31:
The following methods and assumptions were used by the Company in determining the estimated fair value of its financial instruments:
The Company, through its affiliate SLNY, has an agreement with an unrelated company whereby the unrelated company reimburses SLNY for benefits, expenses and interest credits for Focus V and Galaxy V fixed annuities issued in 2000 if the asset pool backing the liability is insufficient.
The Company also acts as the reinsurer of risk under the lapse protection benefit under certain universal life contracts issued by SLOC. One hundred percent of such risk is retroceded to Sun Life Financial Insurance and Annuity Company (Bermuda) Ltd.
The Company, through its affiliate SLNY, has an agreement with an unrelated company whereby the unrelated company reinsures the morbidity risks of SLNY's group stop loss contracts. Under this agreement, certain stop loss benefits are reinsured on a yearly renewable term basis. The agreement provides that the unrelated company will reinsure specific claims for amounts above $1,000,000 per claim for stop loss contracts ceded by SLNY.
The following table sets forth the change in the pension plans' projected benefit obligations and assets, as well as the plans' funded status at December 31:
The accumulated benefit obligation at the end of 2003 and 2002 was $169.0 million and $140.0 million, respectively.
The Company relies on historical market returns from Ibbotson Associates (1926-2002) to determine its overall long term rate of return on asset assumption. Applying Ibbotson's annualized market returns of 12% stock, 5.8% bonds and 3.8% cash to the Company's target allocation results in an expected return consistent with the one used by the Company for purposes of determining the benefit obligation.
The asset allocation for the Company's pension plan assets for 2003 and 2002 measurement, and the target allocation for 2004, by asset category, are as follows:
Equity securities include SLF common stock in the amount of $3.0 million and $2.4 million for 2003 and 2002, respectively.
The Company sponsors and participates in a 401(k) savings plan for which substantially all employees of at least age 21 are eligible to participate at date of hire. Under the plan, the Company matches, up to specified amounts, the employees' contributions to the plan.
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, (in 000's):
In order to measure the post-retirement benefit obligation for 2003, the Company assumed a 11% annual rate of increase in the per capita cost of covered health care benefits. In addition, medical cost inflation is assumed to be 10% in 2004 and assumed to decrease gradually to 5.5% for 2009 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. A one-percentage point change in assumed health care cost trend rates would have the following effect:
Federal income taxes attributable to the consolidated operations are different from the amounts determined by multiplying income before federal income taxes by the expected federal income tax rate of 35%. The Company's effective rate differed from the federal income tax rate as follows:
Management evaluates the results of the operating segments on an after-tax basis. The Company does not depend on one or a few customers, brokers or agents for a significant portion of its operations.
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 leases various facilities and equipment under operating leases with terms of up to 25 years. As of December 31, 2003, minimum future lease payments under such leases were as follows:
To the Board of Directors and Stockholder of Sun Life Assurance Company of Canada (U.S.)
We have audited the consolidated balance sheets of Sun Life Assurance Company of Canada (U.S.) and subsidiaries (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of income, comprehensive income, stockholder's equity, and cash flows for each of the two years in the period ended December 31, 2003. 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.
We previously audited and reported on the consolidated statements of income, comprehensive income, stockholder's equity, and cash flows of Sun Life Assurance Company of Canada (U.S.) and subsidiaries for the year ended December 31, 2001, prior to the restatement for the 2003 merger of Sun Life Assurance Company of Canada (U.S.) and Keyport Life Insurance Company, which was accounted for at historical cost as required by Statement of Financial Accounting Standards No. 141 "Business Combinations" for transfers of assets among affiliates (the "2003 Merger"). The contribution of Sun Life Assurance Company of Canada (U.S.) to revenues and net income represented $631.3 million and $(12.7) million of the respective restated totals. Separate financial statements of Keyport Life Insurance Company included in the 2001 restated consolidated statements of income, comprehensive income, stockholder's equity, and cash flows were audited and reported on separately by other auditors. We also audited the combination of the accompanying consolidated statements of income, comprehensive income, stockholder's equity, and cash flows for the year ended December 31, 2001, after restatement for the 2003 Merger; in our opinion, such consolidated statements have been properly combined on the basis described in Note 1 of the notes to consolidated financial statements.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities". As discussed in Note 1 to the consolidated financial statements, effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets". As discussed in Note 1 to the consolidated financial statements, effective October 1, 2003, the Company adopted the provisions of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51."