Sun Life 2012 Annual Report Download - page 57

Derivative Financial Instruments and Risk Mitigation
The fair value of derivative assets held by the Company was $2.1 billion, while the fair value of derivative liabilities was $0.6 billion as
at December 31, 2012. Derivatives designated as hedges for accounting purposes and those not designated as hedges represented
6.9% and 93.1%, respectively, on a total notional basis.
Derivatives designated as hedges for accounting purposes are designed to minimize balance sheet and income statement
mismatches. These derivatives are documented at inception and hedge effectiveness is assessed on a quarterly basis.
We use derivative instruments to manage risks related to interest rate, equity market and currency fluctuations and in replication
strategies to reproduce permissible investments. We use certain foreign exchange agreements designated as fair value hedges to
manage foreign currency fluctuations associated with AFS assets. Certain interest rate swaps are used to hedge interest rate exposure
of associated liabilities. Certain equity forwards are designated as cash flow hedges of the anticipated payments of awards under
certain stock-based compensation plans. We also use currency swaps designated as net investment hedges to reduce foreign
exchange fluctuations associated with certain net investments in foreign subsidiaries. Our hedging strategy does not hedge all risks;
rather, it is intended to keep us within our risk tolerance limits.
In addition to the general policies and monitoring, we use a variety of tools in counterparty risk management. Over-the-counter
derivative transactions are performed under ISDA Master Agreements. A Credit Support Annex accompanies most of the ISDAs, which
establish requirements for collateral.
The values of our derivative instruments are set out in the following table. The use of derivatives is measured in terms of notional
amounts, which serve as the basis for calculating payments and are generally not actual amounts that are exchanged.
Derivative Assets and Liabilities
($ millions) 2012(1) 2011(1)
As at December 31
Net fair value 1,519 1,573
Total notional amount 42,478 50,859
Credit equivalent amount 953 1,026
Risk-weighted credit equivalent amount 88
(1) Amounts as at December 31, 2012 do not include assets of the Discontinued Operations which are separately disclosed in Assets of disposal group classified as held for
sale. Comparative 2011 amounts have not been restated to reflect this presentation.
The total notional amount of derivatives in our portfolio decreased to $42.5 billion as at December 31, 2012, from $50.9 billion at the
end of 2011. This decrease is attributable to notional balances of $15.0 billion included in the Discontinued Operations and the fair
value of these derivatives is separately disclosed in Assets and Liabilities of disposal group classified as held for sale. This is offset by
an increase of $6.6 billion, primarily related to interest rate swaps and swaptions entered into for the purposes of economically hedging
against interest rate risk including disintermediation risk and to improve the matching of our assets and liabilities.
As the regulator of the Canadian insurance industry, OSFI provides guidelines to quantify the use of derivatives. The credit equivalent
amount, a measure used to approximate the potential credit exposure, is determined as the replacement cost of the derivative
contracts having a positive fair value plus an amount representing the potential future credit exposure.
The risk-weighted credit equivalent amount is a measure used to determine the amount of capital necessary to support derivative
transactions for certain Canadian regulatory purposes. It is determined by weighting the credit equivalent amount according to the
nature of the derivative and the creditworthiness of the counterparties.
As at December 31, 2012, the credit equivalent amounts for interest rate contracts, foreign exchange contracts, and equity and other
contracts were $231 million, $700 million and $22 million, respectively. The corresponding risk-weighted credit equivalent amounts
were $2.5 million, $5.2 million and $0.3 million, respectively.
Impaired Assets
The invested asset values and ratios presented in this section are based on the carrying value of the respective asset categories.
Carrying values for FVTPL and AFS invested assets are generally equal to fair value.
Financial assets that are classified as FVTPL, which represented 46.1% of our invested assets as at December 31, 2012, do not have
allowances for losses since changes in the fair value of these assets are recorded to income and the assets are recorded at fair value
on our Consolidated Statements of Financial Position. In the event of default, if the amounts recovered are insufficient to satisfy the
related insurance contract liability cash flows that the assets are intended to support, credit exposure may be greater than the carrying
value of the asset.
In the absence of objective evidence of impairment, impairment losses are not recognized on AFS debt securities, stocks and other
invested assets if their amortized cost is greater than their fair value, resulting in an unrealized loss recognized in other comprehensive
income. Unrealized losses may be due to interest rate fluctuations or depressed fair values in sectors which have experienced
unusually strong negative market performance. The fair value of AFS securities in an unrealized loss position amounted to $2.5 billion
and the associated unrealized losses amounted to $0.04 billion as at December 31, 2012. Our gross unrealized losses as at
December 31, 2012, for FVTPL and AFS debt securities were $0.17 billion and $0.03 billion, respectively, compared with $1.0 billion
and $0.1 billion, respectively, as at December 31, 2011. The decrease in gross unrealized losses was largely due to the impact of
decreasing interest rates and tightening credit spreads during the year.
Impaired mortgages and loans, net of allowance for losses, amounted to $146 million as at December 31, 2012, $240 million lower
than the December 31, 2011, level for these assets.
Management’s Discussion and Analysis Sun Life Financial Inc. Annual Report 2012 55