Sun Life 2010 Annual Report Download - page 65

These factors can also give rise to liquidity risk if we are forced to sell assets at depressed market prices in order to fund our
commitments. Market changes and volatility could be the result of general capital market conditions or specific social, political or
economic events.
Market Risk Management Governance and Control
We employ a wide range of market risk management practices and controls, as outlined below:
• Enterprise-wide risk appetite and tolerance limits have been established for market risk
• Ongoing monitoring and reporting of market risk sensitivities against pre-established risk tolerance limits
• Detailed asset-liability/market risk management policies, guidelines and procedures are in place
• Management and governance of market risks is achieved through various asset-liability management committees that oversee
key market risk strategies and tactics, review compliance with applicable policies and standards, and review investment and
hedging performance
• Hedging and asset-liability management programs are maintained in respect of key selected market risks
• Product development and pricing policies that require a detailed risk assessment and pricing provisions for material market risks
• Stress-testing techniques, such as Dynamic Capital Adequacy Testing, are used to measure the effects of large and sustained
adverse market movements
• Reserve provisions are established in accordance with standards set forth by the Canadian Institute of Actuaries
•Target capital levels that exceed regulatory minimums.
Equity Market Risk
We are exposed to equity risk from a number of sources. Our primary exposure to equity risk arises, in connection with the
underwriting of benefit guarantees on variable annuity and segregated fund annuity contracts (i.e., segregated fund products in SLF
Canada, variable annuities in SLF U.S. and run-off reinsurance in our Corporate segment). These benefit guarantees are linked to
underlying fund performance and may be triggered upon death, maturity, withdrawal or annuitization.
We also derive a portion of our revenue from fee income generated by our asset management businesses and from certain
insurance and annuity contracts where fee income is levied on account balances that generally move in line with equity market
levels. Accordingly, adverse fluctuations in the market value of such assets would result in corresponding adverse impacts on our
revenue and net income. In addition, declining and volatile equity markets may have a negative impact on sales and redemptions
(surrenders) for this business, resulting in further adverse impacts on our net income and financial position.
We also have direct exposure to equity markets from the investments supporting other general account liabilities, surplus and
employee benefit plans. These exposures generally fall within our risk-taking philosophy and appetite and are therefore generally
not hedged.
Interest Rate Risk
Interest rate risk is the potential for financial loss arising from changes or volatility in interest rates or credit/swap spreads when
assets and liability cash flows do not coincide. We are exposed to interest rate risk when the cash flows from assets and the policy
obligations they support are significantly mismatched, as this may result in the need to either sell assets to meet policy payments
and expenses or reinvest excess asset cash flows in unfavourable interest rate environments. The impact of changes or volatility in
interest rates or credit/swap spreads are reflected in the valuation of our financial assets and liabilities for insurance contracts in
respect of insurance and annuity products.
Certain products have explicit or implicit interest rate guarantees in the form of settlement options, minimum guaranteed crediting
rates and guaranteed premium rates. If investment returns fall below those guaranteed levels, we may be required to increase
liabilities or capital in respect of these insurance contracts. The guarantees attached to these products may be applicable to both
past premiums collected and future premiums not yet received. Our primary residual exposure to interest rate risk arises from
certain insurance products with guaranteed premium rates or minimum interest guarantees. These products are included in our
asset-liability management program and the residual interest rate exposure is managed within risk tolerance limits.
Declines in interest rates or narrowing credit/swap spreads can result in compression of the net spread between interest earned on
investments and interest credited to policyholders. Declines in interest rates or narrowing credit/swap spreads may also result in
increased asset calls, mortgage prepayments and net reinvestment of positive cash flows at lower yields, and therefore adversely
impact our profitability and financial position. In contrast, increases in interest rates or a widening of credit/swap spreads may have a
material impact on the value of fixed income assets, resulting in depressed market values, and may lead to losses in the event of the
liquidation of assets prior to maturity.
Significant changes or volatility in interest rates, or credit/swap spreads could have a negative impact on sales of certain insurance
and annuity products, and adversely impact the expected pattern of redemptions (surrenders) on existing policies. Increases in
interest rates or widening credit/swap spreads may increase the risk that policyholders will surrender their contracts, forcing us to
liquidate investment assets at a loss and accelerate recognition of certain acquisition expenses. While we have established hedging
programs in place and our insurance and annuity products often contain surrender mitigation features, these may not be sufficient to
fully offset the adverse impact of the underlying losses on asset sales.
We also have direct exposure to interest rates and credit/swap spreads from investments supporting other general account liabilities,
surplus and employee benefit plans. Lower interest rates or a narrowing of credit/swap spreads will result in reduced investment
income on new fixed income asset purchases. Conversely, higher interest rates or wider credit/swap spreads will reduce the value of
our existing assets. These exposures generally fall within our risk-taking philosophy and appetite and are therefore generally not
hedged.
Management’s Discussion and Analysis Sun Life Financial Inc. Annual Report 2010 61