Sun Life 2015 Annual Report Download - page 66

The movement of the items in the table above from December 31, 2014 to December 31, 2015 was primarily as a result of the following
factors:
(i) the total fund values decreased due to the natural run-off of the block net of new sales and unfavourable equity market
movements, partially offset by the weakening of the Canadian dollar against the U.S. dollar;
(ii) the amount at risk increased primarily due to unfavourable equity market movements and the weakening of the Canadian dollar;
(iii) the total value of guarantees increased due to the weakening of the Canadian dollar, partially offset by the natural run-off of the
block net of new sales; and
(iv) the total insurance contract liabilities increased due to lower interest rates, unfavourable equity movements and the weakening of
the Canadian dollar.
Segregated Fund Hedging
Our hedging programs use derivative instruments to mitigate the interest and equity related exposure of our segregated fund contracts.
As at December 31, 2015, over 90% of our segregated fund contracts, as measured by associated fund values, were included in a
hedging program. While a large percentage of contracts are included in the hedging program, not all of our market risk exposure
related to these contracts is hedged. For those segregated fund contracts included in the hedging program, we generally hedge the
value of expected future net claims costs and associated margins.
The following table illustrates the impact of our hedging program related to our sensitivity to a 50 basis point and 100 basis point
decrease in interest rates and a 10% and 25% decrease in equity markets for segregated fund contracts as at December 31, 2015 and
December 31, 2014.
Impact of Segregated Fund Hedging ($ millions)
December 31, 2015
Changes in interest rates(3) Changes in equity markets(4)
Net income sensitivity(1)(2) 50 basis point
decrease
100 basis point
decrease 10% decrease 25% decrease
Before hedging (200) (450) (200) (600)
Hedging impact 200 500 150 500
Net of hedging – 50 (50) (100)
December 31, 2014
Changes in interest rates(3) Changes in equity markets(4)
Net income sensitivity(1)(2) 50 basis point
decrease
100 basis point
decrease 10% decrease 25% decrease
Before hedging (200) (400) (150) (500)
Hedging impact 200 400 150 400
Net of hedging – – – (100)
(1) Net income sensitivities have been rounded to the nearest $50 million.
(2) Since the fair value of benefits being hedged will generally differ from the financial statement value (due to different valuation methods and the inclusion of valuation margins
in respect of financial statement values), this will result in residual volatility to interest rate and equity market shocks in reported income and capital. The general availability
and cost of these hedging instruments may be adversely impacted by a number of factors, including volatile and declining equity and interest rate market conditions.
(3) Represents a parallel shift in assumed interest rates across the entire yield curve as at December 31, 2015 and December 31, 2014. Variations in realized yields based on
factors such as different terms to maturity and geographies may result in realized sensitivities being significantly different from those illustrated above. Sensitivities include
the impact of re-balancing interest rate hedges for dynamic hedging programs at 10 basis point intervals (for 50 basis point changes in interest rates) and at 20 basis point
intervals (for 100 basis point changes in interest rates).
(4) Represents the change across all equity markets as at December 31, 2015 and December 31, 2014. Assumes that actual equity exposures consistently and precisely track
the broader equity markets. Since in actual practice, equity-related exposures generally differ from broad market indices (due to the impact of active management, basis risk
and other factors), realized sensitivities may differ significantly from those illustrated above. Sensitivities include the impact of re-balancing equity hedges for dynamic
hedging programs at 2% intervals (for 10% changes in equity markets) and at 5% intervals (for 25% changes in equity markets).
Our hedging strategy is applied both at the line of business or product level and at the Company level using a combination of longer-
dated put options and dynamic hedging techniques (i.e., frequent re-balancing of short-dated interest rate and equity derivative
contracts). We actively monitor our overall market exposure and may implement tactical hedge overlay strategies (primarily in the form
of futures contracts) in order to align expected earnings sensitivities with risk management objectives.
Real Estate Risk
Real estate risk is the potential for financial loss arising from fluctuations in the value of, or future cash flows from, our investments in
real estate. We are exposed to real estate risk arising from fluctuations in the value of, or future cash flows on, real estate classified as
investment properties. We may experience financial losses resulting from the direct ownership of real estate investments or indirectly
through fixed income investments secured by real estate property, leasehold interests, ground rents, and purchase and leaseback
transactions. Real estate price risk may arise from external market conditions, inadequate property analysis, inadequate insurance
coverage, inappropriate real estate appraisals or from environmental risk exposures. We hold direct real estate investments that
support general account liabilities and surplus, and fluctuations in value will impact our profitability and financial position. A material
and sustained increase in interest rates may lead to deterioration in North American real estate values. An instantaneous 10%
decrease in the value of our direct real estate investments as at December 31, 2015 would decrease net income by approximately
$175 million ($150 million decrease as at December 31, 2014). Conversely, an instantaneous 10% increase in the value of our direct
real estate investments as at December 31, 2015 would increase net income by approximately $175 million ($150 million increase as at
December 31, 2014).
64 Sun Life Financial Inc. Annual Report 2015 Management’s Discussion and Analysis