During the last three months of 2023, the median solvency ratio of the defined benefit (DB) plans in Mercer’s database dropped an astonishing 9%! For many plan sponsors, this was a reminder that financial markets move quickly and don’t always deliver good news.

Few DB sponsors are eager to revisit the funded status roller coaster of the last 25 years. This desire for stability, coupled with other factors such as the upcoming implementation of the Pension Protection Act and Canada’s decision to cease issuing real return bonds, may increase pension risk transfer action.

This article covers how plan sponsors can get the most attention (and the best price!) from insurers in this new environment.

Anti-Hero: What’s driving pension de-risking?

As mentioned, there are several factors that are spurring DB plan sponsors to consider pension risk transfer (also known as purchasing group annuities):

  • Strong funded positions. Despite the recent drop in funded status, most DB plans are still in excellent financial health. Mercer estimates that over 80% of the DB plans in their Canadian universe are fully funded on a solvency basis with a median funded ratio of 116%. This allows plan sponsors the financial flexibility to de-risk.
  • Uncertainty over inflation-linked annuity pricing. The federal government announced the cessation of the real return bond (RRB) program in November 2022. Insurers rely on RRBs to hedge inflation-linked annuities. While RRBs continue to be widely available in the secondary market, it’s unclear how long this will last. A future shortage of RRBs will likely lead to an increase in the price of inflation-linked annuities. Plan sponsors with inflation-linked benefits may want to purchase annuities before that happens.
  • Implementation of the Pension Protection Act (PPA). The PPA will come into effect for existing DB plans in 2027 and will give super-priority to DB plan deficits in the event of plan sponsor insolvency. As a result, plan sponsors may want to reduce the chance and size of DB plan deficits through pension risk transfer.
  • Decrease management time and attention. The funded status roller coaster of the last 25 years created cash and accounting surprises for many plan sponsors. These surprises distracted management teams from focusing on their core businesses. Most plan sponsors want to avoid revisiting this uncertain period, which may lead them to further de-risk their DB plans.

Already for 2024, we’re tracking about $18 billion of potential group annuity transactions. This is more than double the size of the 2023 market. Not all of these transactions are expected to place in 2024, but they provide perspective on the growing number of plan sponsors considering pension risk transfer.

In some cases, plan sponsors will be repeat buyers. In 2023, there were more than 20 transactions that involved plan sponsors purchasing annuities for a second (or third or more) time. This highlights the important role that pension risk transfer plays in some plan sponsors’ de-risking toolkits.

Love Story: Is an annuity purchase right for you?

Deciding whether to purchase annuities involves many considerations and it’s helpful for a plan sponsor to start by engaging their consultant. There are several factors to consider, including:


Considerations for an annuity purchase

Solvency liability impact

The cost of purchasing annuities is often lower than a plan sponsor’s solvency liability – after adjusting for life expectancy and inflation-linked benefits. Consultants and insurers can provide valuable input as to how the cost of purchasing annuities is likely to compare to the plan sponsor’s solvency liability.

Asset portfolio

The yield on annuities compares very favorably to the yield on provincial and corporate bonds. In addition, an annuity provides risk transfer. A plan sponsor may want to compare the yield of the “super bond” annuity to the risk-adjusted yield of the assets in their portfolio.

Inflation-linked benefits

As mentioned earlier, the price of inflation-linked annuities could increase as RRBs become scarcer. Plan sponsors with inflation-linked benefits might consider purchasing annuities sooner rather than later.

Longevity risk

Longevity risk is the risk that plan members live longer than expected and a plan sponsor will have to make additional contributions to the DB plan. Over the last 50 years, unexpected improvements in longevity have increased the costs of a typical DB plan by 25 to 30%. A new longevity table is under development by the Canadian Institute of Actuaries and may show that once again Canadians are living longer than expected.

Accounting impact

Purchasing annuities will impact a plan sponsor’s financial statements. Consultants can help quantify this impact.

If an annuity purchase isn’t right for a plan sponsor, then they may want to consider other de-risking alternatives such as better matching their assets and liabilities.

You Belong with Me: How to get the most attention (and best price!)?

In a world where there is increasing demand for pension risk transfer, it’s important to speak to consultants and insurers early in the process. Addressing these topics will make an annuity purchase more attractive to insurers, make the transaction go smoothly and likely lead to a better price:

  • Timing. To get the proper attention from consultants and insurers, it’s important to be thoughtful about when to bring an annuity quote to market. For example, too many quotes coming to market in the same month may mean that insurers can’t bid on all quotes. In the UK and the US where market demand has already increased, team availability at consultants and insurers is often a major consideration of when to bring an annuity quote to market.
  • Structuring. Consultants and insurers can provide helpful feedback on the best way to structure an annuity quote. For example, should the quote be brought as a single tranche or several tranches over time? Should each tranche be divided based on factors such as the expected longevity of the group?
  • Data cleansing. To make the process efficient, avoid surprises and attract the most insurer interest, it’s important to have clean data. A consultant can help with a data cleansing exercise prior to the annuity purchase.
  • Governance process. To ensure a smooth process, it’s critical for a plan sponsor to define their governance process. Who is approving the transaction and how will information be shared? Is a dry run required to get approvers familiar with the quote day process? How many rounds of bidding will there be on quote day and what feedback will be shared with insurers?

Demand for pension risk transfer in Canada is growing. Interested plan sponsors should think strategically and collaborate with consultants and insurers to get the best price. Working together ensures that even though pension risk transfer is a hot ticket, everyone will get a good seat – unlike a Taylor Swift concert.

This article first appeared in the April 2024 edition of the Observer newsletter, a publication of the Association of Canadian Pension Management (ACPM).

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