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 capital loss carryforwards.
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 $17.7 million and $16.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively.
Other income represents fees charged for the cost of insurance, investment advisory services, asset participation fees, benefit fees and administrative service fees. Other income was $165.2 million and $109.6 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The $55.6 million increase in 2011, as compared to 2010, was primarily due to a $42.9 million increase in benefit fees and administrative services fees from affiliates, a $6.6 million increase in income related to a smaller increase in unearned revenue liabilities in 2011, as compared to 2010, and a $6.2 million increase in cost of insurance fees. The increase in benefit fees was attributable to an increase in the sale of certain variable annuity products with optional living benefit features. These benefit fees are based on benefits not the market value of the related assets.
Income tax (benefit) expense - was $(80.7) million and $71.2 million for the twelve-month periods ended December 31, 2011 and 2010, respectively. The effective tax rates for the same periods were 43.9% and 34.7%, respectively. The effective tax rate for the year ended December 31, 2011 differs from the U.S. federal statutory tax rate of 35% primarily due to tax benefits from the separate account DRD, tax credits and true-up adjustments for prior years. 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 DRD and tax credits offset by true-up adjustments for prior years.
The following provides a summary of operations for the Corporate segment for the years ended December 31, (in 000’s):
The Company discontinues the accrual of income on its holdings for issuers that are in default. The Company’s net investment income would have increased by $2.1 million and $4.6 million for the year ended December 31, 2011 and 2010, respectively, if these holdings were performing. As of December 31, 2011 and 2010, the fair market value of holdings for issuers in default was $19.6 million and $53.9 million, respectively.
Investments in private equity limited partnerships are accounted for by the equity method of accounting.
Please refer to Note 7 of the Company’s consolidated financial statements for further discussion of the Company’s net investment income.
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. Valuation allowances on deferred tax assets are estimated based upon the Company’s assessment of the realizability of such amounts. Please refer to Note 10 of the Company’s consolidated financial statements for further discussion of the Company’s income taxes.
At December 31, 2011 and 2010, the Company had $565.0 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, 2011, 2010 and 2009.
The Company also had an interest rate swap agreement with LLC II with an aggregate notional amount of $900.0 million that effectively converted the floating rate payment obligations under the funding agreements to fixed rate obligations. This interest swap agreement expired on July 6, 2011 due to the maturity of the underlying floating rate funding agreement with LLC II.
Effective December 31, 2009, the Company transferred all of its employees to Sun Life Services with the exception of 28 employees who were transferred to Sun Life Financial Distributors, Inc. (“SLFD”), another affiliate. The tax benefit associated with SLF stock options that had been granted to employees of the Company prior to the employee transfer, is recognized by the Company in stockholder’s equity when these options vest. Neither Sun Life Services nor SLFD are included in the accompanying consolidated financial statements. Concurrent with this transaction, Sun Life Services assumed the sponsorship of the Company’s retirement plans, as discussed in Note 9 to the Company’s consolidated financial statements. As a result of this transaction, the Company transferred to Sun Life Services the plan assets and liabilities, the associated deferred tax asset, and certain property, equipment and software, as summarized in the following table:
To compute the credit loss component of OTTI for corporate bonds on the date of transition (i.e., April 1, 2009), both historical default (by rating) data, used as a proxy for the probability of default, and loss given default (by issuer) projections were applied to the par amount of the bond. For corporate bonds post-transition, the present value of future cash flows using the book yield is used to determine the credit component of OTTI. If the present value of the cash flow is less than the security’s amortized cost, the difference is recorded as a credit loss. The difference between the estimates of the credit related loss and the overall OTTI is the non-credit-related component.
“Monitor List”- Management has concluded that the Company’s amortized cost will be recovered through timely collection of all contractually specified cash flows, but that changes in issuer-specific facts and circumstances require monitoring on a quarterly basis. No OTTI charge is recorded in the Company’s consolidated statements of operations for unrealized loss on securities related to these issuers.
Included in the $171.6 million and $204.6 million of impaired mortgage loans at December 31, 2011 and 2010, were $53.9 million and $119.3 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 exceeded the carrying value of the loans.
Modifications are factored into the determination of the allowance for credit losses by including adjustments to the outstanding recorded investment. The financial effect of a TDR is not recognized when the Company expects to collect cash flows at, or above, the original contract rate. For the year ended December 31, 2011, no financial effect from TDRs was recognized. The following table provides information about the Company’s loans that were modified and how they were modified as a TDR during the year ended:
On June 1, 2010, the master lessee elected to exercise a fixed price purchase option to purchase the equipment and the Company received $22.6 million in cash for its investment in the VIE and realized a $3.4 million gain in its consolidated statement of operations.
Foreign currency swaps are utilized as an economic hedge against changes in foreign currencies associated with certain non-U.S. dollar denominated cash flows.
All derivative transactions are covered under standardized contractual agreements with counterparties, all of which include credit-related contingent features. These standardized agreements include language related to the failure to pay or deliver on an obligation, bankruptcy and additional termination events, such as a credit rating falling below a stipulated level . These triggers generally result in early terminations after a grace period.
The following table shows a reconciliation of the beginning and ending balances for assets which are categorized as Level 3 for the
(2) Included in earnings relating to instruments still held at the reporting date.
Transfers in and/or (out) of Level 3 during the year ended December 31, 2010 are primarily attributable to changes in the observability of inputs used to price the securities.
The Company’s net realized investment gains (losses) on available-for-sale fixed maturity securities and other investments, excluding OTTI losses, consisted of the following for the years ended December 31:
By reinsuring the SPWL product, the Company increased (decreased) net investment income by $48.5 million, $(49.9) million and $(126.6) million for the years ended December 31, 2011, 2010 and 2009, respectively. The Company also increased (decreased) interest credited by $55.4 million, $(71.5) million and $(73.9) million for the years ended December 31, 2011, 2010 and 2009, respectively.
The net investment income ceded for the year ended December 31, 2011 was decreased by $113.3 million due to an interest rate adjustment processed during the year. The interest credited ceded for year ended December 31, 2011 was decreased by $113.3 million due to policy reinstatements and interest rate adjustments processed during the year. The adjustment was recorded to correct the Company’s prior year policy loan balances that were overstated by $113.3 million due to inaccurate interest rates applied to certain SPWL policies’ loan balances. The adjustment did not have any impact on the interest credited and net investment income, net of reinsurances, reported in the Company’s consolidated statement of operations due to the 100% funds-withheld reinsurance agreement with SLOC noted above. The adjustment also resulted in a $113.3 million decrease in policy loans, contractholder deposit funds and other policy liabilities, reinsurance receivable, and reinsurance payable in the Company’s consolidated balance sheet at December 31, 2011.
On January 6, 2011, the IRS issued a Revenue Agent’s Report for the Company for tax years 2005 and 2006. The Company disagrees with some of the issues and is in the process of filing a protest. While the final outcome of the appeal and ongoing tax examinations is not determinable, the Company has adequate liabilities accrued and does not believe that any adjustments would be material to its financial position.
The Company and its subsidiaries are parties to threatened or pending legal proceedings, including ordinary routine litigation incidental to their business, both as a defendant and as a plaintiff. While it is not possible to predict the resolution of these proceedings, management believes, based upon currently available information, that the ultimate resolution of these matters will not be materially adverse to the Company's financial position, results of operations or cash flows.