Sun Life’s Defined Benefit Solutions (DBS) team hosted Focus 2023 in early April. This webinar centered on helping defined benefit plan sponsors manage pension risk. Two plan sponsors – West Fraser and Montreal Port Authority – joined us for the event and generously shared tips and insights from their own de-risking journeys.
We’ve heard from attendees that these sessions are very valuable, so I’m sharing my top five takeaways in case you couldn’t attend:
1. The group annuity market hit another step rate
The 2022 Canadian group annuity market was $7.8 billion – slightly higher than the 2021 market of $7.7 billion.1
When we started DBS 15 years ago, the group annuity market was about $1 billion per year. This consisted largely of terminating pension plans forced to purchase annuities. As plan sponsors embraced proactive de-risking, the market achieved several step changes – first to $2.5 billion, then to $4.5 billion and now to $8 billion.2
Over 85 plan sponsors purchased group annuities in 2022. Fifteen of these plan sponsors were repeat buyers3 – meaning they were not purchasing annuities for the first time. Incredibly, the annuity purchases by these repeat buyers made up about half of the $7.8 billion market – showing the continuing value of annuities as a de-risking tool.
2. Plan sponsors are taking inflation risk off the table
Everyone is trying to mitigate the impact of inflation and plan sponsors are no different. Over $900 million of inflation-linked annuities were purchased in 2022.4 This is about 50% more than 2021 and an unbelievable five times more than 2020.
In the past, there was a gap between the price of inflation-linked annuities and the amounts held on plan sponsors’ financial statements. Philippe Rickli, Principal at Normandin Beaudry, explained, “There was a perception that indexed annuities were expensive. Insurers have improved their portfolios, refined mortality assumptions to try to make that cost more appealing to pension plans. Since 2017, we’ve seen strong, but more importantly, consistent pricing on fully indexed annuities.”
Philippe also shared, “In 2022, with the rise of inflation, a lot of fully indexed plans observed losses. We got quite a few calls from clients thrilled they had transferred the risk over to insurance companies.”
The Federal government’s recent decision to stop real return bond issuance may create more interest and make 2023 an even busier year for inflation-linked annuities.
3. New generation LDI is providing new opportunities
Heather Wolfe, Senior Managing Director & Head Canadian Business Development, SLC Management, shared how new generation liability driven investing (LDI) is helping plan sponsors.
Heather clarified that LDI is a framework. It considers all assets and liabilities – not just the ones being hedged. In addition, “An LDI strategy is determined based on each investor's unique objectives – some are focused on going concern and stable contributions. Others are thinking about solvency and avoiding special payments.”
Here are three themes Heather is seeing:
- A broadening of the LDI investment toolkit beyond core fixed income to include private assets, real assets and even annuities.
- The use of synthetic solutions (e.g., derivatives, overlays or leverage) by smaller plans to hedge risk and enhance returns.
- The use of non-Canadian bonds to provide more diversification and yield than can be found in the Canadian market.
4. De-risking is a journey
De-risking doesn’t have to be “all or nothing” and can be an incremental journey. Elaine Jensen, General Manager, Human Resources at West Fraser, emphasized this point. “Dipping our toe in the water with a small transaction to begin with, and then growing that to larger closed plans, then to open plans, and finally to inflation-linked plans, really did work for us.”
De-risking can take many forms including pension plan mergers, plan design changes, investment portfolio de-risking, lump sum windows and annuity purchases. Often de-risking is most powerful when these options are combined.
For example, pension plans often increase the proportion of fixed income assets in their portfolios prior to purchasing annuities. This reduces volatility and is called “getting annuity ready.”
5. Proper governance is critical
Plan sponsors might have different de-risking motivations, ranging from limiting the impact on corporate financial statements to focusing on their core businesses. Ultimately, they are aiming to reduce the risks associated with their respective plans.
Nadia Ivanova, Director, Analysis, Planning and Treasurer at Montreal Port Authority, explained, “A lot of defined benefit pension fund sponsors are not in the pension business. They want to turn these liabilities over to companies whose core competency is to manage long term liabilities without any detriment to the plan participants and retirees.”
No matter what the motivation, taking time to develop a governance structure is critical. Thoughtful governance can really come in handy when purchasing annuities. Isabelle Clément, Partner at Normandin Beaudry, highlighted, “Purchasing annuities … is more than just an investment. It's an irreversible transaction, and it will affect the future funding requirements of the plan. The actual decision to transact must occur within just a few hours. So, the governance framework around the actual transaction must be tight and carefully thought through in advance.”
These five highlights are just a taste of the interesting discussions from Focus 2023. Thank you to our Sun Life team members Dhvani, Heather and Mathieu as well our expert guest speakers, Elaine, Nadia, Isabelle and Philippe for sharing your experience and insights.
To learn more about de-risking, watch the event recording.
1 LIMRA, February 2023.
2 LIMRA, February 2023.
3 Sun Life estimates as of December 31, 2022.
4 Sun Life estimates as of December 31, 2022.