Sun Life 2012 Annual Report Download - page 80

assumptions. Our margins tend to be at the high end of the range for expenses and future equity and real estate returns and in the mid-
range for mortality, morbidity, policyholder behaviour, and future interest rates. When considering the aggregate impact of margins, the
actuary assesses the consistency of margins for each assumption across each block of business to ensure there is no double counting
or omission and to avoid choosing margins that might be mutually exclusive. In particular, the actuary chooses similar margins for
blocks of business with similar characteristics, and also chooses margins that are consistent with other assumptions, including
assumptions about economic factors. The actuary is guided by Canadian actuarial standards of practice in making these professional
judgments about the reasonableness of margins for adverse deviations.
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.
Critical Accounting Estimates Key Risk Factors
Significant factors affecting the determination of policyholders’ benefits, the methodology by which they are determined, their
significance to the Company’s financial condition and results of operations are described below.
Non-fixed Income Market Movements
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.
Interest Rates
We generally maintain distinct asset portfolios for each major line of business. Under the current Canadian Asset Liability Method, 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.
For certain products, including participating insurance and certain forms of universal life policies and annuities, policyholders share
investment performance through routine changes in the amount of dividends declared or in the rate of interest credited. These products
generally have minimum interest rate guarantees.
Hedging programs are in place to help mitigate the impact of interest rate movements.
Mortality
Mortality refers to the rates at which death occurs for defined groups of people. 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.
Policy Termination Rates
Policy termination rates refer to the rate at which policies terminate prior to the end of the contractual coverage period. 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.
Operating Expenses and Inflation
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.
78 Sun Life Financial Inc. Annual Report 2012 Management’s Discussion and Analysis