Sun Life 2012 Annual Report Download - page 137

The best estimate assumptions and margins for adverse deviations are reviewed at least annually and revisions are made when
appropriate. The choice of assumptions underlying the valuation of insurance contract liabilities is subject to external actuarial peer
review.
Mortality
Mortality refers to the rates at which death occurs for defined groups of people. Life Insurance mortality assumptions are generally
based on our five-year average experience. Our experience is combined with industry experience where our own experience is
insufficient to be statistically valid. Assumed mortality rates for life insurance and annuity contracts include assumptions about future
mortality improvement in accordance with Canadian actuarial standards of practice.
Morbidity
Morbidity refers to both the rates of accident or sickness and the rates of recovery therefrom. Most of our disability insurance is
marketed on a group basis. We offer critical illness policies on an individual basis in Canada and Asia, long-term care on an individual
basis in Canada and medical stop-loss insurance is offered on a group basis in the United States. In Canada, group morbidity
assumptions are based on our five-year average experience, modified to reflect any emerging trend in recovery rates. For long-term
care and critical illness insurance, assumptions are developed in collaboration with our reinsurers and are largely based on their
experience. In the United States, our experience is used for both medical stop-loss and disability assumptions, with some consideration
of industry experience.
Lapse and Other Policyholder Behaviour
Lapse
Policyholders may allow their policies to lapse prior to the end of the contractual coverage period by choosing not to continue to pay
premiums or by surrendering their policy for the cash surrender value. Assumptions for lapse experience on life insurance are generally
based on our five-year average experience. Lapse rates vary by plan, age at issue, method of premium payment, and policy duration.
Premium Payment Patterns
For universal life contracts, it is necessary to set assumptions about premium payment patterns. Studies prepared by industry or the
actuarial profession are used for products where our experience is insufficient to be statistically valid. Premium payment patterns
usually vary by plan, age at issue, method of premium payment and policy duration.
Expense
Future policy-related expenses include the costs of premium collection, claims adjudication and processing, actuarial calculations,
preparation and mailing of policy statements and related indirect expenses and overheads. Expense assumptions are mainly based on
our recent experience using an internal expense allocation methodology. Inflationary increases assumed in future expenses are
consistent with the future interest rates used in scenario testing.
Investment Returns
Interest Rates
We generally maintain distinct asset portfolios for each major line of business. Under CALM, the future cash flows from insurance
contracts and the assets that support them are projected under a number of interest rate scenarios, some of which are prescribed by
Canadian actuarial standards of practice. Reinvestments and disinvestments take place according to the specifications of each
scenario, and the liability is set based on the range of possible outcomes.
Non-fixed Income Rates of Return
We are exposed to equity markets through our segregated fund products (including variable annuities) that provide guarantees linked
to underlying fund performance and through insurance products where the insurance contract liabilities are supported by non-fixed
income assets.
For segregated fund products (including variable annuities), we have implemented hedging programs involving the use of derivative
instruments to mitigate a large portion of the equity market risk associated with the guarantees. The cost of these hedging programs is
reflected in the liabilities. The unhedged portion of risk for these products reflects equity market risks associated with items such as
provisions for adverse deviation and a portion of fee income that is not related to the guarantees provided.
The majority of non-fixed income assets which are designated as FVTPL support our participating and universal life products where
investment returns are passed through to policyholders through routine changes in the amount of dividends declared or in the rate of
interest credited. In these cases, changes in non-fixed income values are largely offset by changes in insurance contract liabilities.
Asset Default
As required by Canadian actuarial standards of practice, insurance contract liabilities include a provision for possible future default of the
assets supporting those liabilities. The amount of the provision for asset default included in the insurance contract liabilities is based on
possible reductions in future investment yield that vary by factors such as type of asset, asset credit quality (rating), duration and country
of origin. The asset default assumptions are comprised of a best estimate plus a margin for adverse deviations, and are intended to
provide for loss of both principal and income. Best estimate asset default assumptions by asset category and geography are derived
from long-term studies of industry experience and the Company’s experience. Margins for adverse deviation are chosen from the
standard range (of 25% to 100%) as recommended by Canadian actuarial standards of practice based on the amount of uncertainty in
the choice of best estimate assumption. The credit quality of an asset is based on external ratings if available (public bonds) and internal
ratings if not (mortgages and corporate loans). Any assets without ratings are treated as if they are rated below investment grade.
In contrast to asset impairment provisions and changes in FVTPL assets arising from impairments, both of which arise from known
credit events, the asset default provision in the insurance contract liabilities covers losses related to possible future (unknown) credit
events. Canadian actuarial standards of practice require the asset default provision to be determined taking into account known
impairments that are recognized elsewhere on the balance sheet. The asset default provision included in the insurance contract
liabilities is re-assessed each reporting period in light of impairments, changes in asset quality ratings and other events that occurred
during the period.
Notes to Consolidated Financial Statements Sun Life Financial Inc. Annual Report 2012 135