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 under a renewable lease, with terms not exceeding five years. The home office of SLNY consists of office space in New York, New York, and is leased from an unrelated party. The Company is party to a guarantee agreement under which it guarantees the payment obligations of SLFD, under an office lease dated April 13, 2007.
Pursuant to Instruction I(2)(a) to Form 10-K, the Company elects to omit Management’s Discussion and Analysis of Financial Position and Results of Operations. Below is management’s narrative analysis of the Company’s results of operations explaining the reasons of material changes in the Company’s Consolidated Statements of Operations between the years ended December 31, 2010 and December 31, 2009.
Acquisition costs consist of commissions, underwriting and other costs that vary with and are primarily related to the production of new business. Acquisition costs related to deposit-type contracts, primarily deferred annuity, universal life (“UL”) and guaranteed investment contracts (“GICs”) are deferred and amortized with interest in proportion to the present value of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits are composed of net investment income, net realized and unrealized investment gains and losses, life and variable annuity fees, surrender charges, interest credited, policyholder benefits and direct variable administrative expenses.
The value of customer renewals acquired (“VOCRA”) represents the actuarially determined present value of projected future profits arising from the existing in-force business to the next policy renewal date. VOCRA 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.
The Company uses derivative financial instruments for risk management purposes to economically hedge against specific interest rate risk, to economically hedge guaranteed benefits in its variable products, to alter investment exposures arising from mismatches between assets and liabilities, and to minimize the Company’s exposure to fluctuations in interest rates, foreign currency exchange rates and equity market conditions. The derivative instruments used by the Company include swap agreements, swaptions, call/put options, foreign currency contracts and futures. The Company also records derivatives for certain guaranteed benefits embedded in variable and fixed indexed annuity products at fair value. The Company does not employ hedge accounting treatment. The Company believes that these derivatives provide economic hedges against the risks noted and the cost of formally documenting the effectiveness of the fair value of the hedged assets in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 815, “Derivatives and Hedging,” is not justified. As a result, the unrealized gains and losses are recognized immediately as derivative income or loss. Changes in the level of interest rates or equity markets will cause the value of these derivatives to change. Since a portion of the liabilities that are being hedged are not carried at fair value, the changes in the fair value of the derivatives will cause fluctuation in the reported earnings from period to period as foreign currency exchange rates, equity markets and interest rate change.
Effective January 1, 2008, the Company adopted FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” which defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. FASB ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between knowledgeable, unrelated willing parties at the measurement date, using inputs, including assumptions and estimates, a market participant would utilize. Due to these assumptions and estimates, the amount that may be realized in a true sale may differ significantly from the estimated fair value. In determining fair value, the Company uses various methods including market, income and cost approaches. The Company utilizes valuation techniques that maximize the use of observable inputs and minimizes the use of unobservable inputs, including third-party pricing services, independent broker quotes, and pricing models.
The following table presents the fair value of assets and liabilities, as categorized in the Company’s fair value hierarchy as of December 31, 2010 (in 000’s):
In determining the fair value of the Company’s derivative financial instruments, including swaps, and options the Company considers counterparty credit risk, as well as its own credit risk. In order to mitigate credit risk exposure, the Company transacts with counterparties that have a similar rating as the Company, prices its derivative liabilities based on its own credit rating, and generally holds collateral service agreements for its net derivative exposure with each counterparty.
The derivative instrument receivable included in Level 3 relates to certain equity cliquet options. At December 31, 2010 and 2009, the value of these options was $13.8 million and $8.8 million, respectively. The derivative instrument payable included in Level 3 relates to the Company’s agreement with Credit and Repackaged Securities Limited Series 2006-10 Trust (the “CARS Trust”) (see Note 1 of the Company’s consolidated financial statements included in Part II, Item 8 of this annual report on Form 10-K for a discussion of the CARS Trust). At December 31, 2010 and 2009, the value of the derivative instrument payable held in Level 3 was $27.3 million and $34.3 million, respectively. Approximately $7.0 million of the market gains included in earnings for the year ended December 31, 2010 were related to Level 3 derivative instruments, which were measured using significant unobservable inputs.
At December 31, 2010 and 2009, the value of embedded derivative liabilities held in Level 3 was $133.9 million and $391.4 million, respectively.
Third-party pricing services typically derive 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 models to develop a security price based on future expected cash flows discounted at an estimated market rate using collateral performance and vintages. In some circumstances, third-party pricing services may price certain securities via independent broker quotes which utilize inputs that may be difficult to corroborate with observable market-based data. In accordance with FASB ASC Topic 820, the Company has analyzed the third-party pricing services’ valuation methodologies and related inputs, and also has evaluated the various types of securities in its investment portfolio to determine an appropriate FASB ASC Topic 820 fair value hierarchy level based upon trading activity and the observability of market inputs.
At December 31, 2010, $263.8 million of structured securities classified as ABS, RMBS and CMBS, were classified as Level 3, representing 64.0% of the Company’s total Level 3 fixed maturity securities and 12.0% of the total structured securities at December 31, 2010.
For privately-placed fixed maturity securities, fair values are estimated using a fair value model, which takes into account credit spreads for a variety of public and private securities of similar credit risk, maturity, prepayment and liquidity characteristics. A portion of privately placed fixed maturity securities are also priced using market prices or dealer quotes. The Company’s ability to liquidate positions in privately placed fixed securities could be impacted to a significant degree by the lack of an actively traded market. Although the Company believes that its estimates reasonably reflect the fair value of those instruments, its key assumptions about risk-free interest rates, risk premiums, performance of underlying collateral (if any) and other factors may not reflect those of an active market.
The Company’s fixed maturity securities are classified as either trading or 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. Securities which the Company has elected to measure at fair value under FASB ASC Topic 825 “Financial Instruments” are classified as trading securities. Although classified as trading securities, the Company’s intent is to not sell these securities in the near term.
The Company discontinues the accrual of income on its holdings for issuers that are in default. Investment income would have increased by $4.6 million and $4.3 million for the years ended December 31, 2010 and 2009, respectively, if these holdings were performing. As of December 31, 2010 and 2009, the fair market value of holdings for issuers in default was $53.9 million and $26.0 million, respectively.
Under the applicable asset and liability method for recording deferred income taxes, deferred taxes are recognized when assets and liabilities have different values for financial statement and tax reporting purposes, using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. The Company’s differences between the bases of assets and liabilities used for financial statement versus tax reporting primarily result from actuarial liabilities, policy acquisition expenses, unrealized gains and losses on investments, and net operating loss (“NOL”) carryforwards, as well as a capital loss carryforwards.
The twelve-month period ended December 31, 2010 as compared to the twelve-month period ended December 31, 2009:
On December 31, 2009, the Company paid a dividend of all of the issued and outstanding common stock of the Company’s wholly-owned subsidiary, Sun Life Vermont, to the Parent. As a result of this transaction, Sun Life Vermont is no longer the Company’s wholly-owned subsidiary and was not included in the Company’s consolidated balance sheet at December 31, 2009. In addition, Sun Life Vermont’s net income for the year ended December 31, 2009 is separately presented as “income from discontinued operations, net of tax,” in the Company’s consolidated statements of operations. The following table provides a summary of the results of operations for Sun Life Vermont for the year ended December 31, 2009 (in 000's):
The significant changes in the Company’s consolidated statements of operations during 2010 as compared to 2009, excluding Sun Life Vermont are discussed below:
Net investment income - was $1,390.2 million and $2,582.3 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. Investment income, excluding the mark-to-market of the trading portfolio, net realized gains (losses) related to trading securities, partnership income and ceded investment income, was $861.4 million and $993.7 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The decrease of $132.3 million during 2010, as compared to 2009, was the result of lower average investment yields which decreased investment income by approximately $61.7 million, as well as lower invested assets which decreased investment income by approximately $70.6 million.
Investment income on funds-withheld reinsurance portfolios is included as a component of net investment income in the Company’s consolidated statements of operations. The Company ceded net investment income of $75.6 million and $139.1 million for the twelve-month periods ended December 31, 2010 and 2009, respectively, under the funds-withheld reinsurance agreements between the Company and certain of its affiliates related to the Company’s SPWL and certain of its UL policies.
The $(149.3) million net derivative loss during the twelve-month period ended December 31, 2010, as compared to the $(39.9) million net derivative loss during the same period ended December 31, 2009, was primarily due to a $(266.1) million net loss related to interest rate contracts. These changes were partially offset by a $111.2 million and $45.1 million decrease in derivative losses related to futures contracts and equity contracts, respectively.
The $45.1 million decrease in derivative loss in 2010 as compared to 2009 was due to equity contracts. The $26.7 million loss during the twelve-month period ended December 31, 2010 was primarily attributable to the expiration of certain of the Company’s long-dated equity options during the year. The $71.9 million loss during the twelve month period ended December 31, 2009 was primarily related to decrease in the fair value of certain put options due to changes in the equity market during the year. The Company purchases put options on major indices to economically hedge its obligations under the guaranteed minimum benefits on certain variable annuity contracts.
Fee and other income - were $511.0 million and $385.8 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. Fee and other income consist primarily of mortality and expense charges, rider fees, surrender charges and other income. Mortality and expense charges and rider fees are based on the market values of the assets in the separate accounts supporting the contract. Mortality and expense charges and rider fees combined were $385.2 million and $293.6 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. Variable product fees represented 1.56% and 1.36% of the average variable annuity separate account balances for the twelve-month periods ended December 31, 2010 and 2009, respectively. Average separate account assets were $24.7 billion and $21.6 billion for the twelve-month periods ended December 31, 2010 and 2009, respectively.
Surrender charges represent revenues earned on the early withdrawal of fixed, fixed index, variable annuity, UL and variable universal life (“VUL”) policyholder balances. Surrender charges on fixed, fixed index and variable annuities, UL and VUL surrenders generally are assessed at declining rates applied to policyholder surrenders during the first four to ten years of the contract. Total surrender charges were $16.2 million and $20.1 million for the twelve-month periods ended December 31, 2010 and 2009, respectively.
The Company tests its VOBA asset for future recoverability and has determined that the asset is not impaired at December 31, 2010 and 2009. The Company tests its VOCRA asset for future recoverability, and has determined that the VOCRA asset was not impaired at December 31, 2010. However, the Company’s VOCRA asset was determined to be impaired at December 31, 2009. As a result, the Company recorded an impairment charge of $2.6 million to amortization expense during the year ended December 31, 2009. The impairment charge was allocated to the Group Protection segment.
Goodwill impairment - The Company completed the required impairment test of goodwill and indefinite-lived intangible assets during the second quarter of 2010 and concluded that these assets were not impaired. Therefore, no impairment charge was recorded during the twelve-month period ended December 31, 2010.
Other operating expenses - were $318.2 million and $248.2 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The $70.0 million change in 2010 as compared to 2009, was primarily due to a $44.4 million increase in non-deferrable commission expense related primarily to an increase in the sale of certain variable annuity products and a $23.1 million increase in other operating expenses primarily due to severance costs related to staff restructuring during the current year, advertising expenses related to the Company’s branding campaign and other project-related costs. The remaining $2.5 million was attributable to an increase in premium taxes.
Income tax expense - was $71.2 million and $335.6 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The effective tax rates for the same periods were 34.7% and 27.7%, respectively. The effective tax rate for the year ended December 31, 2010 differs from the U.S. federal statutory tax rate of 35% primarily due to tax benefits from the separate account dividends received deduction and tax credits, offset by true-up adjustments related to the 2009 tax return and a deferred tax benefit related to 2008 goodwill impairment. The effective tax rate for the year ended December 31, 2009 differs from the U.S. federal statutory tax rate of 35% primarily due to the release of the valuation allowance against deferred tax assets for impairment losses on investment assets, tax benefits from the separate account dividends received deduction and tax credits.
The following provides a summary of net income from operations by segment, excluding the Sun Life Vermont discontinued operations.
The segment’s principal products are described below for the years ended December 31, 2010 and 2009:
On September 6, 2006, the Company entered into an agreement with the CARS Trust, whereby the Company is the sole beneficiary of the CARS Trust. The Company has consolidated this trust in accordance with ASC Topic 810 “Consolidation” and reported the CARS Trust in the Wealth Management Segment. The impact of this agreement on the Company’s financial statements is discussed in Note 1 of the Company’s consolidated financial statements presented in Part II, Item 8 of this annual report on Form 10-K.
The following is a summary of operations for the Wealth Management Segment for the years ended December 31 (in 000’s):
The Wealth Management Segment had pre-tax income of $246.2 million and $1,199.4 million for the years ended December 31, 2010 and 2009, respectively. The significant changes are discussed below.
Total revenues were $1,761.0 million and $2,823.0 million for the twelve-month periods ended December 31, 2010 and 2009, respectively. The $1,062.0 million change was primarily due to decreases of $1,066.6 million in net investment income and $118.0 million in net derivative income in 2010 as compared to 2009. These decreases were offset by a $112.3 million increase in fee and other income, a $6.8 million decrease in net realized investment losses and a $3.2 million increase in premiums and annuity considerations.
The $118.0 million decrease in net derivative income in 2010 as compared to 2009, primarily related to changes in the fair value of interest rate swap agreements. The decrease in the fair value of interest rate swap agreements for the twelve-month period ended December 31, 2010, as compared to an increase in the fair value of the interest rate swap agreements during to the twelve-month period ended December 31, 2009, was primarily the result of changes in interest rates. These decreases were partially offset by an increase in income related to changes in the fair value of equity futures which was positively impacted by a less significant increase in equity markets during the twelve-month period ended December 31, 2010 as compared to the twelve-month period ended December 31, 2009.
The $334.2 million decrease in DAC and VOBA amortization was attributable to a $365.9 million decrease in amortization expense and interest. The change in amortization expense was primarily due to a decrease in actual gross profit during the twelve-month period ended December 31, 2010, as compared to the twelve-month period ended December 31, 2009. The decline in gross profit was primarily due to a significant increase in the fair value of trading fixed maturity securities in 2009 as compared to a modest increase in 2010. The amortization expense and interest also includes a $209.1 million decrease related to loss recognition expense. In addition, the decrease in amortization expense was offset by a $31.7 million increase in expenses primarily driven by updates to profitability projection and assumption changes for certain annuity products.
The $138.6 million increase in policyowner benefits for the twelve-month period ended December 31, 2010, as compared to 2009, was primarily due to a $179.9 million increase in reserves and a $21.7 million increase in SIA amortization and deferrals related to certain variable annuity products. These increases were offset by decreases of $46.8 million in death benefits and $16.3 million in annuity payments. The increase in reserves was mainly related to a $150.1 million decrease in GMDB reserves on certain variable annuity products during 2009 which were attributable to changes in equity markets during that period. The increase in GMDB reserves during 2010 was driven by assumption changes related to certain variable annuity products.
The following provides a summary of operations for the Individual Protection segment, excluding Sun Life Vermont, for the years ended December 31 (in 000's):
Total revenues were $66.4 million and $71.7 million for the years ended December 31, 2010 and 2009, respectively. The $5.3 million decrease in total revenues was primarily caused by a decrease of $42.6 million in net investment income, offset by increases of $36.1 million in embedded derivative income and $1.2 million in net realized investment gains.
The decrease of $42.6 million in net investment income resulted primarily from a $40.7 million decrease in the fair market value of fixed maturity securities in the trading portfolio in 2010, as compared to 2009. The significant tightening of credit spreads during the year ended December 31, 2009 resulted in a significant increase in market value of the trading portfolio. The tightening of credit spreads was less significant during the year ended December 31, 2010, which resulted in a smaller increase in market value of the trading portfolio.
The increase of $36.1 million in embedded derivative income resulted from the embedded derivative liabilities increasing more moderately in 2010, as compared to 2009. The increase in embedded derivative liabilities was more pronounced in 2009 due to the inception of the BarbCo 3 agreement. The moderate increase in derivative liabilities in 2010 was due to changes in interest rates and the tightening of credit spreads being less significant in 2010 as compared to 2009.
Total benefits and expenses were $68.6 million and $40.5 million for the years ended December 31, 2010 and 2009, respectively. The $28.1 million increase in benefits and expenses resulted from increases in other operating expenses, DAC amortization and interest credited of $19.1 million, $10.3 million and $1.1 million, respectively, offset by decreases in interest expense and policyowner benefits of $1.3 million and $1.1 million, respectively.
The $19.1 million increase in other operating expenses resulted primarily from a decrease in ceded expenses related to a reduction in sales of products associated with the BarbCo 3 reinsurance agreement. Of the $10.3 million increase in DAC amortization, $5.1 million resulted from higher estimated gross profits in the investment portfolio associated with the DAC asset and $5.2 million resulted from higher death claims under certain VUL policies.
The following provides a summary of operations for the Group Protection segment for the years ended December 31 (in 000’s):
The decrease of $8.1 million in policyowner benefits resulted primarily from a decrease in assumed disability business. The $3.6 million decrease in VOBA and VOCRA amortization reflects more stable amortization of VOCRA in 2010 as compared to 2009. In the fourth quarter of 2009, the Company determined that the Group Protection segment’s VOCRA asset was impaired and recorded an impairment charge of $2.6 million, included in amortization. In addition, amortization expense in 2010 included no VOBA amortization, as this asset was fully amortized as of December 31, 2009. VOBA amortization in 2009 totaled $0.9 million.
The Corporate segment consists of the unallocated capital of the Company, its debt financing, and items not otherwise attributable to the other segments.
The Corporate segment had a pre-tax loss of $59.3 million and $34.6 million for the years ended December 31, 2010 and 2009 respectively. The $24.7 million decrease in pre-tax income was attributable to a decrease in total revenues of $31.3 million, offset by a decrease in total benefits and expenses of $6.6 million.
The decrease of $6.6 million in total benefits and expenses was due to a $20.3 million decrease in interest expense, offset by an increase in other operating expenses of $13.7 million. The decrease of $20.3 million in interest expense resulted primarily from a change in the allocation of interest expense to the operating segments. The increase of $13.7 million in other operating expenses resulted primarily from increases in affiliated company fees and allocated expenses of $24.9 million, offset by decreases in personnel costs of $13.8 million.
(1)Net investment income (loss) includes an increase (decrease) in market value of trading fixed maturity securities of $674.2 million, $2,086.7 million and $(2,603.7) million for the years ended December 31, 2010, 2009 and 2008, respectively.
(3)The $0.9 million and $4.8 million other-than-temporary impairment (“OTTI”) losses for years ended December 31, 2010 and 2009, respectively, represent solely credit losses. The Company incurred no non-credit OTTI losses during the years ended December 31, 2010 and 2009 and as such, no non-credit OTTI losses were recognized in other comprehensive income for these periods.
(4)Amortization of deferred policy acquisition costs and value of business and customer renewals acquired for the year ended December 31, 2008 includes $3.2 million of expenses related to the Company’s adoption of FASB ASC Topic 820, which is further discussed in Note 5.
Net of tax (expense) benefit of $(18.6) million, $(60.1) million and $45.4 million for the years ended December 31, 2010, 2009 and 2008, respectively.
Net of tax (expense) benefit of $(5.5) million and $36.1 million for the years ended December 31, 2009 and 2008, respectively.
The Company did not pay any cash dividends to the Parent in 2010, 2009 and 2008.
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 consolidated financial statements include the accounts of the Company and its subsidiaries. As of December 31, 2010, the Company directly or indirectly owned all of the outstanding shares 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; Clarendon Insurance Agency, Inc., a registered broker-dealer; SLF Private Placement Investment Company I, LLC; Sun Parkaire Landing LLC; 7101 France Avenue Manager, LLC; Sun MetroNorth, LLC; SLNY Private Placement Investment Company I, LLC; and SL Investment DELRE Holdings 2009-1, LLC.
On September 6, 2006 the Company entered into an agreement with Credit and Repackaged Securities Limited Series 2006-10 Trust (the “CARS Trust”). Pursuant to this agreement, the Company purchased a funded note from the CARS Trust which, through a credit default swap entered into by the CARS Trust, is exposed to the credit performance of a portfolio of corporate reference entities. The Company entered into this agreement for yield enhancement related to the fee earned on the credit default swap which adds to the return earned on the funded note.
As the sole beneficiary of the CARS Trust, the Company is required to consolidate this trust under the requirements of Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 810, “Consolidation.” As a result of the consolidation, the Company has recorded in its consolidated balance sheets a credit default swap held by the CARS Trust. At issue, the swap had a seven year term, maturing in 2013. Under the terms of the swap, the CARS Trust will be required to make payments to the swap counterparty upon the occurrence of a credit event, with respect to any reference entity, that is in excess of the threshold amount specified in the swap agreement. In the event that the CARS Trust is required to make any payments under the swap, the underlying assets held by the trust would be liquidated to fund the payment. If the disposition of these assets is insufficient to fund the payment calculated, then under the terms of the agreement, the cash settlement amount would be capped at the amount of the proceeds from the sale of the underlying assets. During the year ended December 31, 2009 the sum of all credit events exceeded the threshold amount and the CARS Trust made cumulative payments of $17.6 million to the swap counterparty. As of December 31, 2010, the maximum future payments of the CARS Trust could be required to make is $37.4 million. The CARS Trust made no payment during the years ended December 31, 2010 and 2008, respectively. At December 31, 2010 and 2009, the fair value of the credit default swap was a liability of $27.3 million and $34.3 million, respectively. As of December 31, 2010 and 2009, the fair value of the assets held as collateral by the CARS Trust was $36.3 million and $35.3 million, respectively. The carrying amount of this interest in a variable interest entity (“VIE”) is included in trading fixed maturity securities on the consolidated balance sheets.
Cash, cash equivalents and short-term investments are highly liquid securities. The Company’s cash equivalents primarily include cash, commercial paper and money market investments which have an original term to maturity of less than three months. Short-term investments include debt instruments with a term to maturity exceeding three months, but less than one year on the date of acquisition. Cash equivalents and short-term investments are held at amortized cost, which approximates fair value.
The Company accounts for its investments in accordance with FASB ASC Topic 320. At the time of purchase, fixed maturity securities are classified as either trading or available-for-sale. Securities, for which the Company has elected to measure at fair value under FASB ASC Topic 825, “Financial Instruments,” are classified as trading securities. Although classified as trading securities, the Company’s intent is to not sell these securities in the near term. Trading securities are carried at aggregate fair value with changes in market value reported as a component of net investment income. Securities that do not meet the trading criterion are classified as available-for-sale. Included with available-for-sale fixed maturity securities are forward purchase commitments on mortgage backed securities, better known as To Be Announced (“TBA”) securities. The Company records TBA purchases on the trade date and the corresponding payable is recorded as an outstanding liability in payable for investments purchased until the settlement date of the transaction. Available-for-sale securities that are not considered other-than-temporarily impaired are carried at fair value with the unrealized gains or losses reported in other comprehensive income.
Prior to the Company’s adoption of the provisions of FASB ASC Topic 320 on April 1, 2009, the Company's accounting policy for impairment on available-for-sale securities required recognition of an OTTI loss through earnings when the Company anticipated that it would be unable to recover all amounts due under the contractual obligations of the security. In addition, in the event that securities were expected to be sold before the fair value of the security recovered to amortized cost, an OTTI loss also would be recorded through earnings.
Structured securities, typically those rated single A or below, are subject to certain provisions in FASB ASC Topic 325, “Investments-Other.” These provisions require the Company to periodically update its best estimate of cash flows over the life of the security. In the event that fair value is less than carrying amount and there has been an adverse change in the expected cash flows (as measured by comparing the original expected cash flows to the current expectation of cash flows, both discounted at the current effective rate), then an impairment charge is recorded to income.
Interest income is recognized on impaired mortgage loans when the collection of contractually specified future cash flows is probable, in which case cash receipts are recorded in accordance with the effective interest rate method. Interest income is not recognized on impaired mortgage loans and these mortgage loans are placed on non-accrual status when the collection of contractually specified future cash flows is not probable, in which case cash receipts are applied, firstly against the carrying value of the loan, then against the provision, and then to income. The accrual of interest resumes when the collection of contractually specified future cash flows becomes probable based on certain facts and circumstances.
Changes in allowances for losses and write-off of specific mortgages are recorded as net realized gain or loss in the Company’s statements of operations. Once the conditions causing impairment improve and future payments are reasonably assured, allowances are reduced and the mortgages are no longer classified as impaired. However, the mortgage loan continues to be classified as impaired if the original terms of the contract have been restructured, resulting in the Company providing an economic concession to the borrower.
If the conditions causing impairment do not improve and future payments remain unassured, the Company typically derecognizes the asset through disposition or foreclosure. Uncollectible collateral-dependent loans are written off through allowances for losses at the time of disposition or foreclosure.
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 depreciated cost. Depreciation of buildings and improvements is calculated using the straight-line method over the estimated useful life of the asset. 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.
The Company uses derivative financial instruments including swaps, swaptions, options and futures as a means of hedging exposure to interest rate, currency and equity price risk. Derivatives are carried at fair value and changes in fair value are recorded as a component of derivative income or loss.
Please refer to Note 7 of the Company’s consolidated financial statements for further discussion of the Company’s net investment income (loss).
VOBA represents the actuarially determined present value of projected future gross profits from the Keyport Life Insurance Company (“Keyport”) in-force policies on November 1, 2001, the date of the Company’s acquisition of Keyport. Prior to December 31, 2009, the Company’s VOBA also included the present value of projected future gross profits from the in-force policies that were transferred to SLNY, based on a series of agreements between SLNY and Sun Life and Health Insurance Company (U.S.) (“SLHIC”), an affiliate, (the “SLHIC to SLNY asset transfer”). VOBA related to Keyport is amortized in proportion to the projected emergence of profits over the estimated life of the purchased block of business; VOBA related to the SLHIC to SLNY asset transfer was amortized in proportion to the projected premium income over the period to the first renewal of the transferred business. As of December 31, 2009, VOBA related to the SLHIC to SLNY asset transfer was fully amortized.
VOCRA represents a portion of the assets that were transferred to SLNY under the SLHIC to SLNY asset transfer. VOCRA is 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. The Company tests its VOCRA asset for impairment on an annual basis. During the year ended December 31, 2009, the Company determined that its VOCRA asset was impaired and recorded an impairment charge of $2.6 million. Please refer to Note 14 of the Company’s consolidated financial statements for the Company’s combined VOBA and VOCRA roll-forward.
The Company’s goodwill represents the intangible asset related to the transfer of goodwill to SLNY under the SLHIC to SLNY asset transfer. Goodwill is allocated to the Group Protection segment In accordance with FASB ASC Topic 350, “Intangibles-Goodwill and Other,” goodwill is tested for impairment on an annual basis. The Company completed the required impairment tests of goodwill during the second quarter of 2010 and concluded that this asset was not impaired.
Prior to December 31, 2009, the Company’s other asset also included property, equipment, leasehold improvements and capitalized software costs. As described in Note 3, effective December 31, 2009, the Company transferred certain property, equipment, leasehold improvements and capitalized software costs to Sun Life Financial (U.S.) Services Company, Inc. (“Sun Life Services”), an affiliate. Depreciation and amortization expenses related to these assets were $1.3 million and $1.3 million for years ended December 31, 2009 and 2008, respectively.
Future contract and policy benefit liabilities include amounts reserved for future policy benefits payable upon contingent events as well as liabilities for unpaid claims due as of the statement date. Such liabilities are established in amounts adequate to meet the estimated future obligations of in-force policies.
The Company has established separate accounts applicable to various classes of contracts providing variable benefits. 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. The activity of the separate accounts is not reflected in the consolidated financial statements except for the following:
In April 2010, the FASB issued ASU 2010-18, “Receivables (Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset - a Consensus of the FASB Emerging Issues Task Force,” which amends FASB ASC Topic 310, “Receivables.” The amendments were made to eliminate diversity in practice in accounting for loans that undergo troubled debt restructuring for those loans that have been included in a pool of loans. Under ASU 2010-18, debt modifications that were made for distressed loans included in a pool of loans, do not trigger the criteria needed to allow for such loans to be accounted for separately outside of the pool. Upon initial adoption, an entity may make a one-time election to terminate accounting for loans as a pool. The election may be made on a pool-by-pool basis and does not prevent the entity from using pool accounting for loans that will be acquired in the future. The amendments in ASU 2010-18 are effective for the first fiscal quarter ending on or after July 15, 2010. Early adoption is permitted. The Company adopted ASU 2010-18 on September 30, 2010 and such adoption did not have a material impact on the Company’s consolidated financial statements.
In March 2010, the FASB issued ASU 2010-11 “Derivatives and Hedging (Topic 815): Scope Exception Related to Embedded Credit Derivatives,” which provides amendments to FASB ASC Topic 815, “Derivatives and Hedging” to clarify the embedded credit derivative scope exception included therein. The amendments address how to determine which embedded credit derivative features are considered to be embedded derivatives that should not be analyzed for potential bifurcation and separate accounting under ASC Topic 815. Under ASU 2010-11, only the embedded credit derivative feature created by subordination between financial instruments is not subject to the bifurcation requirements of ASC Topic 815. However, other embedded credit derivative features would be subject to analysis for potential bifurcation even if their effects are allocated to interests in tranches of securitized financial instruments in accordance with those subordination provisions. The following circumstances would not qualify for the scope exception and are subject to the application of ASC Topic 815 requiring the embedded derivatives to be analyzed for potential bifurcation:
In January 2010, the FASB issued ASU 2010-06 “Fair Value Measurement and Disclosures (Topic 820) - Improving Disclosures about Fair Value Measurements,” which provides amendments to FASB ASC Topic 820 “Fair Value Measurements and Disclosures” in order to provide more robust disclosures about the following:
In August 2009, the FASB issued No. 2009-05, “Fair Value Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value.” This update amends FASB ASC Topic 820 and provides clarification regarding the valuation techniques required to be used to measure the fair value of liabilities where quoted prices in active markets for identical liabilities are not available. In addition, this update clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The guidance provided in ASU No. 2009-05 is effective for the first reporting period, including interim periods, beginning after issuance. The Company adopted this guidance on October 1, 2009. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
The Company adopted the provisions of FASB ASC Topic 815, “Derivatives and Hedging,” which were issued in March 2008. This guidance amends and expands disclosures about an entity’s derivative and hedging activities with the intent to provide users of financial statements with an enhanced understanding of (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. These aspects of FASB ASC Topic 815 are effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged. The Company adopted this guidance on January 1, 2009. The required disclosures are included in Note 4 of the Company’s consolidated financial statements.
The Company adopted the provisions of FASB ASC Topic 805, “Business Combinations,” which were issued in December 2007. This guidance 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 requirements in the accounting guidance on business combinations made by FASB ASC Topic 805 include the following:
Ø Most of the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquired entity shall be measured at their acquisition-date fair values;
Ø Goodwill shall be measured as the excess of the consideration transferred, including the fair value of any contingent consideration, plus the fair value of any noncontrolling interest in the acquired entity, over the fair values of the acquired identifiable net assets;
Ø 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; and
In January 2011, the FASB issued ASU 2011-01, “Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20,” which delays the effective date for the disclosure requirements for public entities related to troubled debt restructurings. ASU 2011-01 applies to all public-entity creditors that modify financing receivables within the guidance given about troubled debt restructurings in ASU 2010-20. The delay is intended to allow the FASB time to complete its deliberations on the definition of a trouble debt restructuring. Currently, it is anticipated that the new disclosure requirements for public entities regarding trouble debt restructurings as described in ASU 2010-20 will be effective for interim and annual periods ending after June 15, 2011.
In December 2010, the FASB issued ASU 2010-28 “Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts - a Consensus of the FASB Emerging Issues Task Force.” The amendments of ASU 2010-28 require reporting units with zero or negative carrying amounts to perform Step 2 of goodwill impairment test if it is more likely than not that a goodwill impairment exists and to consider adverse qualitative factors when performing the impairment test. The amendments in ASU 2010-28 are effective for interim periods and fiscal years beginning after December 15, 2010. Early adoption is not permitted. The Company adopted ASU 2010-28 on January 1, 2011 and does not expect the adoption to have significant impact on the Company’s consolidated financial statements.
On December 31, 2009, the Company paid a dividend of all of Sun Life Vermont’s issued and outstanding common stock, and net assets totaling $94.9 million to the Parent. As a result of this transaction, Sun Life Vermont is no longer the Company’s wholly-owned subsidiary and was not included in the Company’s consolidated balance sheet at December 31, 2009. Sun Life Vermont’s assets and liabilities were as follows at December 31:
The following table represents a summary of the results of operations for Sun Life Vermont which are included in discontinued operations for the years ended December 31:
On November 8, 2007, a long-term financing arrangement was established with a financial institution (the “Lender”) that enables Sun Life Vermont, a subsidiary of the Company prior to December 31, 2009, to fund a portion of its obligations under the reinsurance agreement with SLOC. Under this arrangement, at inception of the agreement, Sun Life Vermont issued an initial floating rate surplus note of $1 billion (the “Surplus Note”) to a special-purpose entity, Structured Asset Repackage Company, 2007- SUNAXXX LLC (“SUNAXXX”), affiliated with the Lender. Pursuant to this arrangement, Sun Life Vermont exercised its option to issue additional Surplus Notes of $200 million and $115 million in 2009 and 2008, respectively, to SUNAXXX. At December 31, 2009 and 2008, the value of the Surplus Note was $1.3 billion and $1.1 billion, respectively. As a result of the dividend of Sun Life Vermont, the $1.3 billion affiliated debt was not included in the Company’s consolidated balance sheets as of December 31, 2009. Pursuant to an agreement between the Lender and the Company’s indirect parent, Sun Life Assurance Company of Canada - U.S. Operations Holdings, Inc. (“SLC - U.S. Ops Holdings”), U.S. Ops Holdings bears the ultimate obligation to repay the Lender and, as such, consolidates SUNAXXX in accordance with FASB ASC Topic 810. Sun Life Vermont agreed to reimburse U.S. Ops Holdings for certain costs incurred in connection with the issuance of the Surplus Note. Sun Life Vermont incurred interest expense of $21.7 million and $46.5 million for the years ended December 31, 2009 and 2008, respectively, which is included in the Company’s consolidated statements of operations as a component of income (loss) from discontinued operations, net of tax.
In 2002, the Company issued two promissory notes with a combined total of $460 million to Sun Life (Hungary) Group Financing Limited Company (“Sun Life (Hungary) LLC”), an affiliate. The proceeds of the notes were used to purchase fixed rate government and corporate bonds. On May 24, 2007, the Company redeemed one of the notes with a principal balance of $380 million and paid $388.7 million to Sun Life (Hungary) LLC, including $8.7 million in accrued interest. On December 29, 2008, the Company redeemed $62.0 million of the $80 million remaining note and paid $64.3 million, including $2.3 million in accrued interest, to Sun Life (Hungary) LLC. At December 31, 2010 and 2009, the Company had $18 million in promissory notes issued to Sun Life (Hungary) LLC. The Company pays interest semi-annually to Sun Life (Hungary) LLC. Related to these promissory notes, the Company incurred interest expense of $1.0 million, $1.0 million and $4.5 million for the years ended December 31, 2010, 2009 and 2008, respectively.
On July 17, 2008, the Company issued a $60 million promissory note to Sun Life (Hungary) LLC with a maturity date of September 27, 2011. The Company paid interest quarterly to Sun Life (Hungary) LLC. Total interest incurred was $1.3 million for the year ended December 31, 2008. The Company used the proceeds of the note for general corporate purposes. On December 29, 2008, the Company redeemed the note and paid $60.8 million to Sun Life (Hungary) LLC, including $0.8 million in accrued interest.
At December 31, 2010 and 2009, the Company had $565 million of surplus notes payable to Sun Life Financial (U.S.) Finance, Inc., an affiliate. The Company expensed $42.6 million for interest on these surplus notes for each of the years ended December 31, 2010, 2009 and 2008.
On September 12, 2006, the Company issued two floating rate funding agreements totaling $900 million to Sun Life Financial Global Funding III, L.L.C. (“LLC III”), an affiliate, due 2013. On April 7, 2008, the Company issued an additional floating rate funding agreement totaling $5.8 million to LLC III. Total interest credited for these funding agreements was $6.2 million, $11.2 million, and $36.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. On September 19, 2006, the Company also issued a $100 million floating rate demand note payable to LLC III. For interest on this demand note, the Company expensed $0.7 million, $1.3 million, and $4.0 million for the years ended December 31, 2010, 2009 and 2008, respectively.
On May 17, 2006, the Company issued a floating rate funding agreement of $900 million to Sun Life Financial Global Funding II, L.L.C. (“LLC II”), an affiliate, due 2011. On April 7, 2008, the Company issued an additional floating rate funding agreement totaling $7.5 million to LLC II. Total interest credited for these funding agreements was $5.4 million, $10.5 million, and $35.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. On May 24, 2006, the Company also issued a $100 million floating rate demand note payable to LLC II. For interest on this demand note, the Company expensed $0.6 million, $1.2 million, and $4.0 million for the years ended December 31, 2010, 2009 and 2008, respectively.
On June 3, 2005 and June 29, 2005, the Company issued two floating rate funding agreements totaling $900 million to Sun Life Financial Global Funding, L.L.C. (“LLC”), an affiliate, due 2010. On April 7, 2008, the Company issued an additional floating rate funding agreement totaling $10 million to LLC. On July 1 and July 8, 2010, the Company paid $900.0 million and $10.0 million, respectively, to the LLC due to the maturity of these funding agreements. Total interest credited for these funding agreements was $2.9 million, $11.3 million and $36.6 million for the years ended December 31, 2010, 2009 and 2008, respectively. On June 10, 2005, the Company also issued a $100.0 million floating rate demand note payable to the LLC which matured on July 6, 2010. On August 6, 2010, the Company paid $100.1 million to LLC, including $140 thousand in interest due to the maturity of the floating rate demand note. For interest on this demand note, the Company expensed $0.5 million, $1.3 million and $4.0 million for the years ended December 31, 2010, 2009 and 2008, respectively.
In accordance with FASB ASC Topic 845, “Nonmonetary Transactions,” all assets and liabilities were transferred at book value and no gain or loss was recognized in the Company’s consolidated statement of operations. The difference between the book value of the transferred assets and liabilities of $48.9 million, net of tax, was recorded by the Company as other comprehensive income and paid-in-capital. Prior to the transfer, this difference between the book value of the transferred assets and liabilities was recorded in the Company’s consolidated balance sheet as a component of accumulated other comprehensive income.
Pursuant to an administrative services agreement between the Company and Sun Life Services which was effective December 31, 2009, Sun Life Services provides human resources services (e.g., recruiting and maintaining appropriately trained and qualified personnel and equipment necessary for the performance of actuarial, financial, legal, administrative and other operational support functions) to the Company. The Company reimburses Sun Life Services for the cost of such services, plus, with respect to certain of those services, pays an arms-length based profit margin to be agreed upon by the parties. Total payments under this agreement were $117.6 million for the year ended December 31, 2010.
Effective December 31, 2009, Sun Life Services and SLOC entered into an administrative services agreement under which Sun Life Services provides to SLOC, as requested, personnel and certain services. Prior to December 31, 2009, the Company had an administrative services agreement with SLOC under which the Company provided personnel and certain services to SLOC, as requested. Pursuant to the agreement with SLOC, the Company recorded reimbursements of $336.0 million and $316.7 million for the years ended December 31, 2009 and 2008, respectively, as a reduction to other operating expenses. Effective December 31, 2009, the Company no longer provides personnel services to SLOC and SLOC no longer reimburses the Company for such services.
The Company has administrative services agreements with SLOC under which SLOC provides, as requested, certain services and facilities on a cost-reimbursement basis. Pursuant to the agreements with SLOC, the Company recorded expenses of $13.0 million, $8.9 million and $9.9 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The Company has an administrative services agreement with Sun Life Information Services Canada, Inc. (“SLISC”), under which SLISC provides administrative and support services to the Company in connection with the Company’s insurance and annuity businesses. Expenses under this agreement amounted to approximately $18.0 million, $15.5 million and $17.6 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The Company has a service agreement with Sun Life Information Services Ireland Limited (“SLISIL”), under which SLISIL provides various insurance related and information systems services to the Company. Expenses under this agreement amounted to approximately $23.5 million, $24.2 million and $24.3 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The Company has an administrative services agreement with SLC - U.S. Ops Holdings, under which the Company provides administrative and investor services with respect to certain open-end management investment companies for which an affiliate, Massachusetts Financial Services Company (“MFS”), serves as the investment adviser, and which are offered to certain of the Company’s separate accounts established in connection with the variable annuity contracts issued by the Company. Amounts received under this agreement were approximately $13.0 million, $8.9 million and $17.2 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The Company has an administrative services agreement with Sun Capital Advisers LLC (“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 $13.0 million, $4.3 million and $2.1 million for the years ended December 31, 2010, 2009 and 2008, respectively. The Company paid $21.4 million, $18.2 million and $18.6 million for the years ended December 31, 2010, 2009 and 2008, respectively, in investment management services fees to SCA.
The Company leases office space to SLOC under lease agreements with terms expiring on December 31, 2014 and options to extend the terms for each of twelve successive five-year terms at fair market rental value, not to exceed 125% of the fixed rent for the term which is then ending. Rent received by the Company under the leases amounted to approximately $12.1 million, $10.1 million, and $10.6 million for the years ended December 31, 2010, 2009 and 2008, respectively. Rental income is reported as a component of net investment income.
During the year ended December 31, 2009, the Company sold certain limited partnership investments to SLOC with a book value of $16.9 million and a fair market value of $22.4 million. The Company recorded a pre-tax gain on the sales of $5.5 million for the year ended December 31, 2009. During the year ended December 31, 2008, the Company sold certain limited partnership investments to SLOC with a book value and fair market value of $87.2 million.
VOBA of $7.6 million is subject to amortization based upon expected premium income over the period from acquisition to the first customer renewal, generally not more than two years. VOBA was fully amortized as of December 31, 2009. VOCRA of $16.2 million is subject to amortization based upon expected premium income over the projected life of the in-force business acquired, which is 20 years. The Company recorded amortization for VOBA and VOCRA for the years ended December 31 as follows:
The amortized cost and fair value of fixed maturity securities held at December 31, 2010, were as follows:
(1) Represents the pre-tax non-credit OTTI loss recorded as a component of accumulated other comprehensive income (“AOCI”) for assets still held at the reporting date.
The amortized cost and estimated fair value by maturity periods for fixed maturity securities held at December 31, 2010 are shown below. Actual maturities may differ from contractual maturities on structured securities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Fixed maturity securities with an amortized cost of approximately $12.3 million and $12.4 million at December 31, 2010 and 2009, respectively, were on deposit with federal and state governmental authorities, as required by law.
As of December 31, 2010 and 2009, 92.4% and 91.1%, respectively, of the Company's fixed maturity securities were investment grade. Investment grade securities are those that are rated "BBB" or better by nationally recognized statistical rating organizations. Securities that are not rated by a nationally recognized statistical rating organization are assigned ratings based on the Company's internally prepared credit evaluations. During 2010, 2009 and 2008, the Company incurred realized losses totaling $0.9 million, $4.8 million and $41.9 million, respectively, for other-than-temporary impairment of value on its available-for-sale fixed maturity securities.
The following table shows the fair value and gross unrealized losses, which includes temporary unrealized losses and the portion of non-credit OTTI losses recognized in AOCI, of the Company’s available-for-sale fixed maturity investments, aggregated by investment category and length of time that the individual securities had been in an unrealized loss position at December 31, 2009.
The following table provides the number of securities of the Company’s available-for-sale fixed maturity securities with gross unrealized losses and a portion of non-credit OTTI losses recognized in AOCI aggregated by investment category at December 31, 2009 (not in thousands):
Beginning on April 1, 2009, the Company presents and discloses OTTI in accordance with FASB ASC Topic 320. Securities whose fair value is less than their carrying amount are considered to be impaired and are evaluated for potential OTTI. If the Company intends to sell, or if it is more likely than not that it will be required to sell an impaired security prior to recovery of its cost basis, the security is considered other-than-temporarily impaired and the Company records a charge to earnings for the full amount of impairment based on the difference between the current carrying amount and fair value of the security. Otherwise, losses on securities which are other-than-temporarily impaired are separated into two categories: credit loss and non-credit loss. The credit loss portion is charged to net realized investment gains (losses) in the consolidated statements of operations, while the non-credit loss is charged to other comprehensive income. When an unrealized loss on an available-for-sale fixed maturity is considered temporary, the Company continues to record the unrealized loss in other comprehensive income and not in earnings.
Structured securities, those rated single A or below in particular, are subject to certain provisions in FASB ASC Topic 325, “Investments-Other.” These provisions require the Company to periodically update its best estimate of cash flows over the life of the security. In the event that the fair value is less than the carrying amount and there has been an adverse change in the expected cash flows (as measured by comparing the original expected cash flows to the current expectation of cash flows, both discounted at the current effective rate), then an impairment charge is recorded to income. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third parties, along with assumptions and judgments about the future performance of the underlying collateral. Losses incurred on the respective portfolios are based on expected loss models, not incurred loss models. Expected cash flows include assumptions about key systematic risks and loan-specific information.
The Company recorded credit OTTI losses in its consolidated statement of operations totaling $0.9 million and $4.8 million for the year ended December 31, 2010 and 2009, respectively on its available-for-sale fixed maturity securities. The $0.9 million credit loss OTTI recorded during the year ended December 31, 2010 was concentrated in corporate debt of a foreign issuer. This impairment was driven primarily by the adverse financial condition of the foreign issuer. The $4.8 million credit loss OTTI recorded during the year ended December 31, 2009 was concentrated in corporate debt of financial institutions. These impairments also were driven primarily by the adverse financial conditions of the issuers.
A loan is considered impaired when it is probable that the principal or interest is not collectible in accordance with the contractual terms of the loan. The allowance for credit losses is estimated using the present value of expected cash flows discounted at the loan’s effective interest rate or the fair value of the collateral, if the loan is collateral dependent. A specific allowance for loan loss is established for an impaired loan if the present value of expected cash flows discounted at the loan’s effective interest rate, or the fair value of the loan collateral, less cost to sell, is less than the recorded amount of the loan. The specific allowance for loan loss was $30.1 million and $17.3 million at December 31, 2010 and 2009, respectively. A general allowance for loan loss is established based on an assessment of past loss experience on groups of loans with similar characteristics and current economic conditions. The general allowance for loan loss was $23.7 million and $25.5 million at December 31, 2010 and 2009, respectively. While management believes that it uses the best information available to establish the allowances, future adjustments may become necessary if economic conditions differ from the assumptions used in calculating them.
Delinquency status is determined based upon the occurrence of a missed contract payment. The following table set forth an age analysis of past due loans in the Company’s mortgage loan portfolio at December 31.
The credit quality indicator for the Company’s mortgage loans is an internal risk rated measure based on the borrowers’ ability to pay and the value of the underlying collateral. The internal risk rating is related to an increasing likelihood of loss, with a low quality rating representing the category in which a loss is first expected. The following table shows the gross carrying value of the Company’s mortgage loans disaggregated by credit quality indicator at December 31, 2010.
Included in the $204.6 million and $215.9 million of impaired mortgage loans at December 31, 2010 and 2009, are $119.3 million and $134.9 million, respectively, of impaired loans that did not have an allowance for loan loss because the fair value of the collateral or the expected future cash flows exceed the carrying value of the loans.
At December 31, 2010, scheduled mortgage loan maturities were as follows:
The Company has made funding commitments of mortgage loans on real estate into the future. The outstanding funding commitments for these mortgages amount to $0.6 million and $51.0 million at December 31, 2010 and 2009, respectively.
The Company had outstanding commitments with respect to funding of limited partnerships of approximately $12.6 million and $12.8 million at December 31, 2010 and 2009, respectively.
The Company uses derivative financial instruments for risk management purposes to hedge against specific interest rate risk, foreign currency exchange rates, equity market conditions, and to alter exposure arising from mismatches between assets and liabilities. Derivative instruments are recorded in the consolidated balance sheets at fair value and are presented as assets or liabilities.
It is common, and the Company’s preferred practice, for the parties to execute a Credit Support Annex (“CSA”) in conjunction with the International Swaps and Derivatives Association Master Agreement. Under a CSA, collateral is passed between the parties to mitigate the market contingent counterparty risk inherent in outstanding positions.
Interest rate swaps are generally used to change the character of cash flows (e.g., fixed payments to floating rate payments) for duration matching purposes and to manage exposures to changes in the risk-free interest rate.
A foreign currency contract is an agreement between two parties to buy and sell currencies at the current market rate, for settlement at a specified future date. Foreign currency contracts are utilized as an economic hedge against changes in foreign currencies associated with certain non-U.S. dollar denominated cash flows.
The Company performs a quarterly analysis of its new contracts, agreements and financial instruments for embedded derivatives. No embedded derivatives required bifurcation from financial assets. However, the Company issues certain annuity contracts and enters into reinsurance agreements that contain derivatives embedded in the contract. Upon issuing the contract, the embedded derivative is separated from the host contract (annuity contract or reinsurance agreement) and is carried at fair value. Please refer to Note 8 of the Company’s consolidated financial statements for further information regarding derivatives embedded in reinsurance contracts; refer to Note 12 for further information regarding derivatives embedded in annuity contracts.
The following is a summary of the Company’s derivative positions at:
Futures contracts include interest rate, equity price and foreign currency exchange risks.
Credit-related triggers include failure to pay or deliver on an obligation past certain grace periods, bankruptcy or the downgrade of credit ratings to below a stipulated level. These triggers apply to both the Company and its counterparty. The aggregate value of all derivative instruments with credit risk-related contingent features that were in a liability position at December 31, 2010 was approximately $362.0 million.
In the event of an early termination, the Company might be required to accelerate payments to counterparties, up to the current value of its liability positions, offset by the value of previously pledged collateral and cross-transaction netting. If payments cannot be exchanged simultaneously at early termination, funds also will be held in escrow to facilitate settlement. If an early termination was triggered on December 31, 2010, the Company would be expected to settle a net obligation of less than $0.1 million.
On January 1, 2008, the Company adopted FASB ASC Topic 820, which defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. The Company utilizes valuation techniques that maximize the use of observable inputs and minimizes the use of unobservable inputs.
The Company has categorized its financial instruments into a three-level hierarchy based on the priority of the inputs to the valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.
Quoted prices for identical or similar assets or liabilities in non-active markets,
The types of assets and liabilities utilizing Level 2 valuations generally include U.S. Government securities not backed by the full faith and credit of the Government, municipal bonds, structured notes and certain asset-backed securities (“ABS”) including collateralized debt obligations, residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”), certain corporate debt, certain private equity investments and certain derivatives, including derivatives embedded in reinsurance contracts.
Prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. They reflect management's own assumptions about the assumptions a market participant would use in pricing the asset or liability.
Generally, the types of assets and liabilities utilizing Level 3 valuations are certain ABS, RMBS, and CMBS, certain corporate debt, certain private equity investments, certain mutual fund holdings and certain derivatives, including derivatives embedded in annuity contracts and certain funding agreements.
(2) Excludes $1,814.1 million, primarily related to investment purchases payable, net of investment sales receivable, that are not subject to FASB ASC Topic 820.
The following table presents the Company’s categories for its assets measured at fair value on a recurring basis as of December 31, 2009:
The following table presents the Company’s categories for its liabilities measured at fair value on a recurring basis as of December 31, 2009:
The methods and assumptions that the Company uses in determining the estimated fair value of its financial instruments that are measured at fair value on a recurring basis are summarized below:
For privately-placed fixed maturity securities, fair values are estimated using models which take into account credit spreads for publicly traded securities of similar credit risk, maturity, prepayment and liquidity characteristics. A portion of privately-placed fixed maturity securities are also priced using market prices or broker quotes.
Cash, cash equivalents and short-term investments: The carrying value for cash, cash equivalents and short-term investments approximates fair value due to the short-term nature and liquidity of the balances.
Other policy liabilities: The fair values of S&P 500 Index and other equity-linked embedded derivatives are produced using standard derivative valuation techniques. Guaranteed minimum accumulation benefit (“GMAB”) or guaranteed minimum withdrawal benefit (“GMWB”) are considered to be derivatives under FASB ASC Topic 815 and are included in contractholder deposit funds and other policy liabilities in the Company’s consolidated balance sheets. Consistent with the provisions of FASB ASC Topic 820, the Company incorporates risk margins and the Company’s own credit standing, as well as changes in assumptions regarding policyholder behavior, in the calculation of the fair value of embedded derivatives.
Other liabilities: This financial instrument consists of issued checks and transmitted wires that have not been cashed and processed in the Company’s bank accounts as of the end of the reporting period. The fair value of other liabilities is consistent with the method used in calculating the fair value of cash and cash equivalents, as described above.
(1) The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities which results in a net zero impact on net income for the Company.
Gains and losses related to Level 3 assets and liabilities, included in the Company’s consolidated statements of operations for the year ended December 31, 2010, are reported as follows:
The following table shows a reconciliation of the beginning and ending balances for liabilities which are categorized as Level 3 for the year ended December 31, 2009:
Gains and losses related to Level 3 assets and liabilities, included in the Company’s consolidated statements of operations for the year ended December 31, 2009, are reported as follows:
The Company determines transfers between levels based on the fair value of each security as of the beginning of the reporting period.
FASB ASC Topic 825 requires disclosure of the fair value of certain financial instruments including those that are not carried at fair value. FASB ASC Topic 825 also excludes certain insurance liabilities and other non-financial instruments from its disclosure requirements. The fair value amounts presented herein do not include the expected interest margin (interest earnings over interest credited) to be earned in the future on investment-type products or other intangible items. Accordingly, the aggregate fair value amounts presented herein do not necessarily represent the underlying value to the Company. Likewise, care should be exercised in deriving conclusions about the Company's business or financial condition based on the fair value information presented herein.
The following table presents the Company’s financial instruments whose carrying amounts and estimated fair values may differ at:
Contractholder deposit funds and other policy liabilities: The fair values of the Company’s general account insurance reserves and contractholder deposits under investment-type contracts (e.g., insurance, annuity and pension contracts that do not involve mortality or morbidity risks) are estimated using discounted cash flow analyses or surrender values based on interest rates currently being offered for similar contracts with maturities consistent with those remaining for all contracts being valued. Those contracts that are deemed to have short-term guarantees have a carrying amount equal to the estimated market value. The fair values of other deposits with future maturity dates are estimated using discounted cash flows.
The Company’s net realized investment gains (losses) on available-for-sale fixed maturity securities and other investments, excluding OTTI losses on fixed maturity securities, consisted of the following for the years ended December 31:
Ceded investment income on funds-withheld reinsurance portfolios is included as a component of net investment income (loss) and is accounted for consistent with the policies discussed in Note 1 of the Company’s consolidated financial statements. The ceded investment income relates to the funds-withheld reinsurance agreement between the Company and certain affiliates and is further discussed in Note 8 to the Company’s consolidated financial statements.
The funds-withheld assets of $1.6 billion and $1.5 billion at December 31, 2010 and 2009, respectively, are comprised of bonds, mortgage loans, policy loans, derivative instruments, and cash and cash equivalents that are managed by the Company. The fair value of the embedded derivative increased (reduced) contractholder deposit funds and other policy liabilities by $14.0 million and $(10.6) million at December 31, 2010 and 2009, respectively. The change in the fair value of this embedded derivative (decreased) increased derivative income by $(24.6) million, $(120.0) million, and $130.6 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The following are the Company’s significant reinsurance agreements that impact the Individual Protection segment.
At the inception of the transaction, BarbCo 3 paid an initial ceding commission to the Company of $41.5 million and the Company recorded a reinsurance payable and related reinsurance receivable of $370.7 million and $329.2 million, respectively. The reinsurance payable included a funds-withheld liability of $247.9 million and a deferred gain of $122.8 million. Pursuant to this agreement, the Company held the following assets and liabilities at:
The Company has other reinsurance agreements with SLOC and several unrelated companies, which provide reinsurance for portions of the net-amount-at-risk under certain individual variable universal life, individual private placement variable universal life, bank owned life insurance (“BOLI”) and corporate owned life insurance (“COLI”) policies. These amounts are reinsured on a monthly renewable term, a yearly renewable term or a modified coinsurance basis. These other agreements decreased revenues by approximately $134.7 million, $173.9 million and $145.4 million and reduced expenses by approximately $140.1 million, $168.5 million and $128.3 million for the years ended December 31, 2010, 2009 and 2008, respectively.
SLNY also has a reinsurance agreement, effective May 31, 2007, to assume the net risks of SLHIC’s New York issued contracts. At December 31, 2010 and 2009, SLNY held policyholder liabilities of $28.6 million and $30.3 million, respectively, related to this agreement. In addition, the reinsurance agreement increased revenues by $47.6 million, $52.9 million and $59.0 million for the years ended December 31, 2010, 2009 and 2008, respectively, and increased expenses by $31.2 million, $44.3 million and $48.6 million for the years ended December 31, 2010, 2009 and 2008, respectively.
The following tables set forth the change in the Pension Plans’ and the Other Post Retirement Benefit Plan’s projected benefit obligations and assets, as well as information on the plans’ funded status at December 31, 2009:
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 Pension Plans and the Other Post Retirement Benefit Plan for the years ended December 31:
The following table shows changes in the Company’s AOCI related to the Pension Plans and the Other Post Retirement Benefit Plan for the following years:
Weighted average assumptions used to determine net (benefit) cost for the Pension Plans and the Other Post Retirement Benefit Plan were as follows:
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 contributed to the RIA from January 1, 2006 through December 31, 2009 and Sun Life Services contributes to the RIA from January 1, 2010 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 Company accounts for current and deferred income taxes in the manner prescribed by FASB ASC Topic 740. A summary of the components of income tax expense (benefit) in the consolidated statements of operations for the years ended December 31 is as follows:
Under the applicable asset and liability method for recording deferred income taxes, deferred taxes are recognized when assets and liabilities have different values for financial statement and tax reporting purposes, using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
The Company’s net deferred tax asset at December 31, 2010 and 2009 was comprised of gross deferred tax assets and gross deferred tax liabilities. The gross deferred tax asset was primarily related to unrealized investment security losses, actuarial liabilities, and net operating loss (“NOL”) carryforwards, as well as a capital loss carryforward generated in 2010 and 2009. At December 31, 2010, the Company’s had $958.2 million of NOL carryforwards and $33.7 million of capital loss carryforwards. At December 31, 2009, the Company had $492.8 million of NOL carryforwards and $193.0 million of capital loss carryforwards. If unutilized, the NOL and capital loss carryforwards will begin to expire in 2023 and 2014, respectively. The Company’s net deferred tax asset was $394.3 million and $549.8 million at December 31, 2010 and 2009, respectively.
The Company performs the required recoverability (realizability) test in terms of its ability to realize its recorded net deferred tax asset. In making this determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income and sources of capital gains, the Company utilizes historical and current operating results and incorporates assumptions including the amount of future federal and state pre-tax operating income, the reversal of temporary differences, and the implementation of prudent and feasible tax planning strategies.
The liability for unrecognized tax benefits (“UTBs”) related to permanent and temporary tax adjustments, exclusive of interest, was $31.2 million, $42.0 million and $50.7 million at December 31, 2010, 2009 and 2008, respectively. Of the $31.2 million, $1.8 million represents the amount of UTBs that, if recognized, would favorably affect the Company’s effective income tax rate in future periods, exclusive of any related interest.
In October 2008, the IRS issued a Revenue Agent’s Report for the Company’s tax years 2003 and 2004. The Company disagreed with some of the adjustments and filed a protest, which was assigned to Appeals in 2009. On May 27, 2010, the IRS held an opening conference for the 2003 and 2004 Appeals. The Company is involved in discussions with the IRS to reach a resolution.
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. Under the terms of the tax sharing agreements, deferred tax assets for tax attributes are realized by the Company when the tax attributes are utilized by the consolidated group. The Company made income tax payments of $21.1 million in 2009, and received income tax refunds of $107.1 million and $113.2 million in 2010 and 2008, respectively.
The following roll-forward summarizes the change in reserve for the GMDBs and GMIBs for the year ended December 31, 2010:
The following roll-forward summarizes the change in reserve for the GMDBs and GMIBs for the year ended December 31, 2009:
GMABs and GMWBs are considered to be derivatives under FASB ASC Topic 815 and are recorded at fair value through earnings. The Company records GMAB and GMWB liabilities in its consolidated balance sheets as part of contractholder deposit funds and other policy liabilities. The net balance of GMABs and GMWBs constituted a liability in the amount of $2.3 million and $250.5 million at December 31, 2010 and 2009, respectively. The Company includes the following unobservable inputs in its calculation of the embedded derivative:
Actively-Managed Volatility Adjustments - This component incorporates the basis differential between the observable implied volatilities for each index and the actively-managed funds underlying the variable annuity product. The adjustment is based on historical actively-managed fund volatilities and historical weighted-average index volatilities.
The following roll-forward summarizes the change in DAC and SIA for the years ended December 31:
The Company wrote down DAC and SIA by $126.0 million and $326.9 million as a result of loss recognition related to certain annuity products for the years ended December 31, 2010 and 2009, respectively. Of the $126.0 million charge for loss recognition in 2010, $117.7 million related to DAC and was reported as amortization of DAC. The remaining $8.3 million related to SIA and was reported as a component of interest credited in the Company’s consolidated statement of operations. The $326.9 million charge for loss recognition in 2009 was reported as a component of amortization of DAC in the Company’s consolidated statement of operations.
(2)SLUS as Parent’s and SLNY’s OTTI losses for the year ended December 31, 2010 represent impairments related to credit loss.
(1)SLUS as parent’s and SLNY’s net investment (loss) income includes a decrease in market value of trading fixed maturity securities of $2,448.8 million and $154.9 million, respectively, for the year ended December 31, 2008.
As described below, the Company conducts business primarily in three operating segments and maintains a Corporate segment to provide for the capital needs of the three operating segments and to engage in other financing related activities. Each segment is defined consistently with the way results are evaluated by the chief operating decision-maker.
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 Individual Protection segment markets, sells and administers a variety of life insurance products sold to individuals and corporate owners of life insurance. The products include whole life, UL and variable life products.
The Group Protection segment markets, sells and administers group life, group long-term disability, group short-term disability, group dental and group stop loss insurance products to small and mid-size employers in the State of New York through SLNY.
The Company and its insurance subsidiaries are required to file annual statements with state regulatory authorities prepared on a statutory accounting basis prescribed or permitted by such authorities. For the year ended December 31, 2008, the Company followed one permitted practice relating to the treatment of its deferred tax assets. For the years ended December 31, 2010 and 2009, there were no permitted practices followed. Statutory surplus differs from stockholder's equity reported in accordance with GAAP primarily because policy acquisition costs are expensed when incurred, policy liabilities are based on different assumptions, investments are valued differently, post-retirement benefit costs are based on different assumptions, and deferred income taxes are calculated differently. The Company’s statutory financials are not prepared on a consolidated basis.
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 $29.6 million in 2011 without prior approval from the New York Commissioner of Insurance. No dividends were paid by SLNY during 2010, 2009 or 2008.
Under insurance guaranty fund laws in each state, the District of Columbia and Puerto Rico, insurers licensed to do business can be assessed by state insurance guaranty associations for certain obligations of insolvent insurance companies to policyholders and claimants. Most of these laws do provide, however, that an assessment may be excused or deferred if it would threaten an insurer's solvency and further provide annual limits on such assessments. Part of the assessments paid by the Company pursuant to these laws may be used as credits for a portion of the associated premium taxes.
In Revenue Ruling 2007-61, issued on September 25, 2007, the IRS announced its intention to issue regulations with respect to certain computational aspects of the dividends-received-deduction (the “DRD”) on separate account assets held in connection with variable annuity contracts. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54, issued on August 16, 2007, that purported to change accepted industry and IRS interpretations of the statutes governing computational questions impacting the DRD. On May 30, 2010, the IRS issued an Industry Director Directive which makes it clear that IRS interpretations prior to Revenue Ruling 2007-54 should be followed until new regulations are issued. New DRD regulations that the IRS proposes for issuance on this matter will be subject to public comment, at which time the insurance industry and other interested parties will have the opportunity to raise comments and questions about the content, scope and application of new regulations. The timing, substance and effective date of the new regulations are unknown, but they could result in the elimination of some or all of the separate account DRD tax benefit that the Company ultimately receives. For the years ended December 31, 2010 and 2009, the Company recorded benefits of $11.5 million and $15.5 million, respectively, related to the separate account DRD. The amounts recorded for the year ended December 31, 2010 included an adjustment of $3.2 million to reflect a reduced run rate of separate account DRD benefits following the filing of the 2009 tax return.
The Company leases various facilities under operating leases with terms of up to five years. As of December 31, 2010, minimum future lease payments under such leases were $40 thousand for 2011. The Company does not have any lease commitments after 2011.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sun Life Assurance Company of Canada (U.S.) and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.