Sun Life 2012 Annual Report Download - page 79

Accounting and Control Matters
Critical Accounting Policies and Estimates
Our significant accounting and actuarial policies are described in Notes 1, 2, 3, 5, 6, 7 and 11 of our 2012 Consolidated Financial
Statements. Management must make judgments involving assumptions and estimates, some of which may relate to matters that are
inherently uncertain, under these policies. The estimates described below are considered particularly significant to understanding our
financial performance. As part of our financial control and reporting, judgments involving assumptions and estimates are reviewed by
the independent auditor and by other independent advisors on a periodic basis. Accounting policies requiring estimates are applied
consistently in the determination of our financial results.
Benefits to Policyholders
General
The liabilities for insurance contracts represent the estimated amounts which, together with estimated future premiums and net
investment income, will provide for outstanding claims, estimated future benefits, policyholders’ dividends, taxes (other than income
taxes) and expenses on in-force insurance contracts.
In determining our liabilities for insurance contracts, assumptions must be made about mortality and morbidity rates, lapse and other
policyholder behaviour, interest rates, equity market performance, asset default, inflation, expenses and other factors over the life of
our products. Most of these assumptions relate to events that are anticipated to occur many years in the future. Assumptions require
regular review and, where appropriate, revision.
We use best estimate assumptions for expected future experience and apply margins for adverse deviations to provide for uncertainty
in the choice of the best estimate assumptions. The amount of insurance contract liabilities related to the application of margins for
adverse deviations to best estimate assumptions is called a provision for adverse deviations.
Best Estimate Assumptions
Best estimate assumptions are intended to be current, neutral estimates of the expected outcome as guided by Canadian actuarial
standards of practice. The choice of best estimate assumptions takes into account current circumstances, past experience data
(Company and/or industry), the relationship of past to expected future experience, anti-selection, the relationship among assumptions
and other relevant factors. For assumptions on economic matters, the assets supporting the liabilities and the expected policy for
asset-liability management are relevant factors.
Margins for Adverse Deviations
The appropriate level of margin for adverse deviations on an assumption is guided by Canadian actuarial standards of practice. For
most assumptions, the standard range of margins for adverse deviations is 5% to 20% of the best estimate assumption, and the
actuary chooses from within that range based on a number of considerations related to the uncertainty in the determination of the best
estimate assumption. The level of uncertainty, and hence the margin chosen, will vary by assumption and by line of business and other
factors. Considerations that would tend to indicate a choice of margin at the high end of the range include:
• The statistical credibility of the Company’s experience is too low to be the primary source of data for choosing the best estimate
assumption;
• Future experience is difficult to estimate;
• The cohort of risks lacks homogeneity;
• Operational risks adversely impact the ability to estimate the best estimate assumption; and
• Experience may not be representative of future experience and the experience may deteriorate.
Provisions for adverse deviations in future interest rates are included by testing a number of scenarios of future interest rates, some of
which are prescribed by Canadian actuarial standards of practice, and determining the liability based on the range of possible
outcomes. A scenario of future interest rates includes, for each forecast period between the balance sheet date and the last liability
cash flow, interest rates for risk-free assets, premiums for asset default, rates of inflation, and an investment strategy consistent with
the Company’s investment policy. The starting point for all future interest rate scenarios is consistent with the current market
environment. If few scenarios are tested, the liability would be the largest of the outcomes. If many scenarios are tested, the liability
would be within a range defined by the average of the outcomes that are above the 60th percentile of the range of outcomes and the
corresponding average for the 80th percentile.
Provisions for adverse deviations in future equity returns are included by scenario testing or by applying margins for adverse
deviations. In blocks of business where the valuation of liabilities employs scenario testing of future equity returns, the liability would be
within a range defined by the average of the outcomes that are above the 60th percentile of the range of outcomes and the
corresponding average for the 80th percentile. In blocks of business where the valuation of liabilities does not employ scenario testing
of future equity returns, the margin for adverse deviations on common share dividends is between 5% and 20%, and the margin for
adverse deviations on capital gains would be 20% plus an assumption that those assets reduce in value by 25% to 40% at the time
when the reduction is most adverse. A 30% reduction is appropriate for a diversified portfolio of North American common shares and,
for other portfolios, the appropriate reduction depends on the volatility of the portfolio relative to a diversified portfolio of North American
common shares.
In choosing margins, we ensure that, when taken one at a time, each margin is reasonable with respect to the underlying best estimate
assumption and the extent of uncertainty present in making that assumption, and also that, in aggregate, the cumulative impact of the
margins for adverse deviations is considered reasonable with respect to the total amount of our insurance contract liabilities. Our
margins are generally stable over time and are generally only revised to reflect changes in the level of uncertainty in the best estimate
Management’s Discussion and Analysis Sun Life Financial Inc. Annual Report 2012 77