Sun Life 2015 Annual Report Download - page 116

Unobservable Inputs and Sensitivity for Level 3 Assets
Our assets categorized in Level 3 of the fair value hierarchy are primarily Investment properties, Debt securities, and Other invested
assets.
The fair value of Investment properties is determined by using the discounted cash flows methodology as described in Note 5.A.i. The
key unobservable inputs used in the valuation of investment properties as at December 31, 2015 include the following:
• Estimated rental value: The estimated rental value is based on contractual rent and other local market lease transactions net of
reimbursable operating expenses. An increase (decrease) in the estimated rental value would result in a higher (lower) fair value.
The estimated rental value varies depending on the property types, which include retail, office, and industrial properties. The
estimated rental value (in dollars, per square foot, per annum) ranges from $12.00 to $40.00 for retail and office properties and from
$3.00 to $11.00 for industrial properties.
• Rental growth rate: The rental growth rate is typically estimated based on expected market behaviour, which is influenced by the
type of property and geographic region of the property. An increase (decrease) in the rental growth rate would result in a higher
(lower) fair value. The rental growth rate (per annum) ranges from 1.0% to 3.0%.
• Long-term vacancy rate: The long-term vacancy rate is typically estimated based on expected market behaviour, which is
influenced by the type of property and geographic region of the property. An increase (decrease) in the long-term vacancy rate
would result in a lower (higher) fair value. The long-term vacancy rate ranges from 2.0% to 10.0%.
• Discount rate: The discount rate is derived from market activity across various property types and geographic regions and is a
reflection of the expected rate of return to be realized on the investment over the next 10 years. An increase (decrease) in the
discount rate would result in a lower (higher) fair value. The discount rate ranges from 5.75% to 10.0%.
• Terminal capitalization rate: The terminal capitalization rate is derived from market activity across various property types and
geographic regions and is a reflection of the expected rate of return to be realized on the investment over the remainder of its life
after the 10-year period. An increase (decrease) in the terminal capitalization rate would result in a lower (higher) fair value. The
terminal capitalization rate ranges from 5.25% to 9.5%.
Changes in the estimated rental value are positively correlated with changes in the rental growth rate. Changes in the estimated rental
value are negatively correlated with changes in the long-term vacancy rate, the discount rate, and the terminal capitalization rate.
Our Debt securities categorized in Level 3, which are included in Debt securities – FVTPL and Debt securities – AFS in the Level 3 roll
forward table, consist primarily of corporate bonds. The fair value of these corporate bonds is generally determined using broker quotes
that cannot be corroborated with observable market transactions. Significant unobservable inputs for these corporate bonds would
include issuer spreads, which are comprised of credit, liquidity, and other security-specific features of the bonds. An increase
(decrease) in these issuer spreads would result in a lower (higher) fair value. Due to the unobservable nature of these broker quotes,
we do not assess whether applying reasonably possible alternative assumptions would have an impact on the fair value of the Level 3
corporate bonds. The majority of our debt securities categorized in Level 3 are FVTPL assets supporting insurance contract liabilities.
Changes in the fair value of these assets supporting insurance contract liabilities are largely offset by changes in the corresponding
insurance contract liabilities under CALM. As a result, though using reasonably possible alternative assumptions may have an impact
on the fair value of the Level 3 debt securities, it would not have a significant impact on our Consolidated Financial Statements.
The Other invested assets categorized in Level 3, which are included in Other invested assets – FVTPL and Other invested assets –
AFS in the Level 3 roll forward table, consists primarily of limited partnership investments. The fair value of our limited partnership
investments are based on net asset value (“NAV”) provided by management of the limited partnership investments. Based on the
unobservable nature of these NAVs, we do not assess whether applying reasonably possible alternative assumptions would have an
impact on the fair value of the Level 3 limited partnership investments.
Valuation Process for Level 3 Assets
Our assets categorized in Level 3 of the fair value hierarchy are primarily Investment properties, Debt securities, and limited
partnership investments included in Other invested assets. Our valuation processes for these assets are as follows:
The fair value of Investment properties are based on the results of appraisals performed annually and reviewed quarterly for material
changes. The valuation methodology used to determine the fair value is in accordance with the standards of the Appraisal Institute of
Canada, the U.S., and the U.K. Investment properties are appraised externally at least once every three years. Investment properties
not appraised externally in a given year are reviewed by qualified appraisers. A management committee, including investment
professionals, reviews the fair value of Investment properties for overall reasonability.
The fair value of Debt securities is generally obtained by external pricing services. We obtain an understanding of inputs and valuation
methods used by external pricing services. When fair value cannot be obtained from external pricing services, broker quotes, or
internal models subject to detailed review and validation processes are used. The fair value of debt securities is subject to price
validation and review procedures to ensure overall reasonability.
The fair value of limited partnership investments, included in Other invested assets, is based on NAV. The financial statements used in
calculating the NAV are generally audited annually. We review the NAV of the limited partnership investments and perform analytical
and other procedures to ensure the fair value is reasonable.
114 Sun Life Financial Inc. Annual Report 2015 Notes to Consolidated Financial Statements