Sun Life 2012 Annual Report Download - page 82

The fair value of government and corporate debt securities is determined using quoted prices in active markets for identical or similar
securities. When quoted prices in active markets are not available, fair value is determined using market standard valuation
methodologies, which include discounted cash flow analysis, consensus pricing from various broker dealers that are typically the
market makers, or other similar techniques. The assumptions and valuation inputs in applying these market standard valuation
methodologies are determined primarily using observable market inputs, which include, but are not limited to, benchmark yields,
reported trades of identical or similar instruments, broker-dealer quotes, issuer spreads, bid prices, and reference data including market
research publications. In limited circumstances, non-binding broker quotes are used.
The fair value of asset-backed securities is determined using quoted prices in active markets for identical or similar securities, when
available, or valuation methodologies and valuation inputs similar to those used for government and corporate debt securities.
Additional valuation inputs include structural characteristics of the securities, and the underlying collateral performance, such as
prepayment speeds and delinquencies. Expected prepayment speeds are based primarily on those previously experienced in the
market at projected future interest rate levels. In instances where there is a lack of sufficient observable market data to value the
securities, non-binding broker quotes are used.
The fair value of equity securities is determined using quoted prices in active markets for identical securities or similar securities. When
quoted prices in active markets are not available, fair value is determined using equity valuation models, which include discounted cash
flow analysis and other techniques that involve benchmark comparison. Valuation inputs primarily include projected future operating
cash flows and earnings, dividends, market discount rates, and earning multiples of comparable companies.
Mortgages and corporate loans are recorded at amortized cost. The fair value of mortgages and corporate loans, for disclosure
purposes only, is determined by discounting the expected future cash flows using a current market interest rate applicable to financial
instruments with a similar yield, credit quality and maturity characteristics. Valuation inputs typically include benchmark yields and risk-
adjusted spreads from current lending activities or loan issuances.
Derivative financial instruments are recorded at fair value with changes in fair value recorded in income unless the derivative is part of
a qualifying hedging relationship for accounting purposes. The fair value of derivative financial instruments depends upon derivative
types. The fair value of exchange-traded futures and options is determined using quoted market prices in active markets, while the fair
value of OTC derivatives is determined using pricing models, such as discounted cash flow analysis or other market standard valuation
techniques, with primarily observable market inputs. Valuation inputs used to price OTC derivatives may include swap interest rate
curves, foreign exchange spot and forward rates, index prices, the value of underlying securities, projected dividends, volatility
surfaces, and in limited circumstances, counterparty quotes.
The fair value of OTC derivative financial instruments also includes credit valuation adjustments to reflect the credit risk of both the
derivative counterparty and ourselves as well as the impact of contractual factors designed to reduce our credit exposure, such as
collateral and legal rights of offset under master netting agreements. Inputs into determining the appropriate credit valuation
adjustments are typically obtained from publicly available information and include credit default swap spreads when available, credit
spreads derived from specific bond yields, or published cumulative default experience data adjusted for current trends when credit
default swap spreads are not available.
The fair value of other invested assets is determined using quoted prices in active markets for identical securities or similar securities.
When quoted prices in active markets are not available, fair value is determined using equity valuation models, which include
discounted cash flow analysis and other techniques that involves benchmark comparison. Valuation inputs primarily include projected
future operating cash flows and earnings, dividends, market discount rates, and earnings multiples of comparable companies.
Investment properties are recorded at fair value with changes in fair value recorded in income. The fair value of investment properties
is generally determined using property valuation models that discount expected future net cash flows at current market interest rates.
Expected future net cash flows include contractual and projected cash flows, forecasted operating expenses, and take into account
interest, rental and occupancy rates derived from market surveys. The estimates of future cash inflows, in addition to expected rental
income from current leases, include projected income from future leases based on significant assumptions that are consistent with
current market conditions. The future rental rates are estimated depending on the actual location, type and quality of the properties,
and take into account market data and projections at the valuation date. The fair values are typically compared to market-based
information, including recent transactions involving comparable assets for reasonability. The methodologies and inputs used in these
models are in accordance with real estate industry valuation standards. Valuations are prepared externally or internally by
professionally accredited real estate appraisers.
Due to their nature, the fair value of policy loans and cash are assumed to be equal to their carrying values, which is the amount these
assets are recorded at in our Consolidated Statements of Financial Position.
Investments for account of segregated fund holders are recorded at fair value with changes in fair value recorded in income. The fair
value of investments for account of segregated fund holders is determined using quoted prices in active markets or independent
valuation information provided by investment management. The fair value of direct investments within investments for accounts of
segregated fund holders, such as short-term securities and government and corporate debt securities, is determined according to
valuation methodologies and inputs described above in the respective asset type sections.
The methodologies and assumptions for determining the fair values of investment contract liabilities are included in Note 11.B of our
2012 Consolidated Financial Statements.
We categorize our financial instruments carried at fair value, based on the priority of the inputs to the valuation techniques used to
measure fair value, into a three level fair value hierarchy as follows:
Level 1: Fair value is based on unadjusted quoted prices for identical assets or liabilities in an active market. The types of financial
instruments classified as Level 1 generally include cash and cash equivalents, certain U.S. government and agency securities, and
exchange traded equity securities and certain segregated and mutual fund units held for account of segregated fund holders.
Level 2: Fair value is based on quoted prices for similar assets or liabilities in active markets, valuation that is based on significant
observable inputs, or inputs that are derived principally from or corroborated with observable market data through correlation or other
means. The types of financial instruments classified as Level 2 generally include Canadian federal, provincial and municipal
80 Sun Life Financial Inc. Annual Report 2012 Management’s Discussion and Analysis