Fitch Ratings has downgraded Sun Life Financial Inc.’s senior unsecured debt rating two notches to ‘A-’ from ‘A+’, and the insurer financial strength ratings of SLF’s primary Canadian and American life insurance subsidiaries one notch to ‘AA-’ from ‘AA’.

The rating agency says that the moves reflect its “updated review of SLF’s exposure to the volatile credit and investment market conditions, which are negatively impacting its investment results and earnings performance”.

“The two notch downgrade of SLF’s parent company ratings reflects Fitch’s application of standard notching, versus narrowed notching previously, primarily as a result of deteriorating fixed-charge coverage, but also because of increased financial leverage,” it says.

“The one notch ratings downgrade of the operating companies was driven by the earnings impact in 2008 of significant levels of asset impairments and credit-related losses, and the impact of the severe decline in equity markets on fees, as well as reserves for segregated fund guarantee benefits (net of hedging) and universal life benefits (which were unhedged),” it says, adding, “While most of the earnings volatility occurred in U.S. operations, primarily in the annuities line, Canadian individual insurance and group wealth businesses, Asian operations and U.S. mutual fund operations were also impacted by credit and equity markets in 2008.”

Fitch notes that it believes that SLF is well-capitalized, but the downgrade of the IFS ratings also reflects the pressure on the capital position in order to support its U.S. insurance operations.

The rating agency also has a negative outlook on the firm, which it attributes to: its view that near-term conditions in the financial markets will likely continue for an extended period, which could cause the company to experience higher-than-expected volatility in its financial results and additional challenges in 2009; the potential for higher-than-expected credit related investment losses; and, the potential need to further increase the capital supporting the U.S. variable annuity business, driven by further declines in equity markets.

Notwithstanding the downgrade and the negative outlook, Fitch stresses that SLF’s ratings strengths, “include balanced and diversified operations, the very strong Canadian franchise with leading market positions and sustainable distribution capabilities, good U.S. niche positions in individual life and annuities and group insurance, good growth prospects for emerging Asian markets, and relatively stable performance in U.S. mutual funds.”

“Disciplined investment strategies have resulted in very strong liquidity and high asset quality, with lower than average consolidated exposure to below-investment-grade bonds and structured securities and a higher than average allocation to Canadian and U.S. Federal and Provincial bonds at 25% of C$59.1 billion in total bonds at Dec. 31, 2008,” it adds, noting that it also believes “the company demonstrates the use of an effective risk management process and continues to make progress on enhancing operating efficiencies.”

Sun Life declined to comment on the rating action.