In the last 15 years, many plan sponsors have solved their pension challenges by transferring pension risk to insurers. Alongside consultants and insurers, they innovated to meet their de-risking objectives – and structured market-making deals in the process.
Today, more plan sponsors than ever are considering group annuities as a de-risking solution, intent on driving further innovation to do so.
Here, the DB Solutions team highlights key messages when responding to questions about pension risk transfer (PRT) market innovation often asked by plan sponsors and industry partners. They illustrate how innovation, through collaboration and customization, has opened the PRT playing field to plans in various situations.
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Q1. How has the PRT market innovated to address plan sponsors’ pension risk challenges?
- The Canadian PRT market has grown significantly over the last 15 years. A large portion of that growth has been the result of market innovation.
- To date, innovations include creating buy-in policies, executing on much larger transactions, addressing risk transfers related to active plan members and finding solutions for inflation-linked plans.
- The role of consultants and insurers in innovation has been to understand the plan sponsor’s objectives and challenges, and then structure a deal within that framework. This customized approach has led them to break new ground.
- The newly created solutions could often be further used to help other plan sponsors. That cycle opened the market to solve the next cohort of challenges.
Q2. How is the 2020 General Motors transaction an example of breaking new ground?
- It’s the largest pension risk transfer arrangement in Canada to date – more than $1.8 billion. It involved 12 to 18 months of work between plan sponsor, consultants and three different insurers. Sun Life’s portion alone was $1.1 billion.
- This jumbo deal was innovative in terms of the combination of market capacity, structure and competitiveness. It’s a great example of how a plan sponsor challenged insurers to deliver a deal of unprecedented size.
- The plan sponsor engaged with insurers early in the process. That enabled them to structure a competitive arrangement with the help of the consultants.
Q3. What are the key challenges in structuring a jumbo deal?
- Asset origination. The larger the deal, the greater the investments required. Insurers either need time to find assets and warehouse them or have a strong conviction they will find them in the short term. This challenge pushes insurers to work more quickly and efficiently to find the right assets needed for the transaction to achieve a competitive price.
- Longevity. A larger deal could have credible mortality experience insurers may want to use. Refining assumptions can lead to significant price changes. A small change in longevity views applied to a large group of retirees can result in a sizable change in price for the transaction.
- Collaboration. This is key to overcoming challenges. The plan sponsor, consultants and insurers can look at these jumbo deals like a merger and acquisition transaction. We’re all partners in it – so how can we make it work successfully? It takes the right partners and excellent communication.
Q4. What’s driving the trend to include active plan members in de-risking deals?
- Traditionally, group annuities have been almost exclusively for retirees, with small groups of deferred members. But some plan sponsors want to annuitize their entire plan in one transaction – including deferred and active members.
- The plan sponsor could be motivated by an upcoming plan windup or a desire to use their time and attention efficiently by only going through the de-risking exercise once.
- An important theme driving success for this type of transaction success is risk sharing. It’s critical to define what risks the plan sponsor is willing to keep and self-insure and the ones they want to transfer to the insurer through the group annuity contract.
- Longevity and investment risks would likely top the list of risks to transfer to an insurer. For active members, future salary increases and timing of retirement, including early retirement subsidies, are likely not risks that are economical to transfer to insurers.
- As with jumbo deals, it’s important to invite insurers early to discussions. They will help triage the different risks and place them into the proper category, once parties are aligned on how they evaluate each risk.
Q5. Inflation is an emerging concern for everyone these days. How are insurers addressing this from a risk transfer perspective?
- Insurers have been working hard on inflation-linked deals for a few years now. It has become an important topic for any plan sponsor with inflation-linked promises.
- At Sun Life, we built a comprehensive inflation framework – as taking on significant exposure to inflation is a risk we take seriously. We developed our expertise in hedging inflation-linked liabilities – not only for 100% Consumer Price Index (CPI) formulas, but also for formulas with floors, caps and offsets. The objective was to optimize inflation risk protection alongside other deal considerations to hit the plan sponsor's price triggers.
- The results have been positive. Insurers have written about $1.4 billion in inflation-linked annuities in the last five years*. For 2022, we expect the market wrote more than $900 million in inflation-linked annuities. And there is a strong transaction pipeline for 2023.
- Insurers and consultants will continue innovating to further develop inflation solutions to meet different plan sponsor needs and price triggers.
Q6. Why is the timing of a deal often considered a challenge?
- For different business reasons, plan sponsors may want to de-risk through annuities right away, yet conditions might not be favourable. The plan may not be fully funded, or the time might be wrong for plan member communications. It could be the right time from a financial and accounting standpoint, but insurers may need more time to structure the deal.
- Advance commitments could be one solution to address timing challenges. This is when a plan sponsor selects the deal partners today and finalizes the transaction in the future. It’s often seen in the U.S. with mega-deals, but it’s happening in Canada too. For example, a few years ago Sun Life managed the Canadian Wheat Board’s liability-driven investment (LDI) portfolio until the time was right for annuities. The mandate was then converted to a group annuity contract.
- Looking to the future, the industry is determined to continue working on solutions to help ease timing challenges for plan sponsors.
Q7. What are the foundational elements for successful innovations in the Canadian PRT market?
- Clarify the plan sponsor’s objectives upfront. In many cases, discussions jump to available solutions. It’s important to start with the challenge or a clearly defined objective. This allows opportunity for innovation versus going right to execution with existing solutions.
- Involve consultants and insurers early in the process. Innovative deals take time and require extensive collaboration. With a conversation at the outset, a plan sponsor can challenge the market to work for them and give industry partners time to structure creative and customized solutions.
- Be open to innovation. With many different plan situations and market variables, customized solutions are becoming the rule, not the exception. The Canadian PRT market has the expertise and track record to break new ground successfully. Innovation will continue to drive new de-risking solutions for DB plan sponsors.
*Sun Life estimates