The greatest attraction of a DB pension plan is the appearance of certainty in the levels of retirement income it promises to its members, which contrasts with the uncertainty of retirement income levels that a DC pension plan can provide to its members. Readers may be interested to discover, though, that their DC pension plan (or other retirement savings plans such as a group RRSP or deferred profit sharing plan) may have a minimum level of DB hidden within it; in fact, it’s highly likely to be the case for any Canadian DC arrangement.

Most Canadian DC plans are funded under arrangements issued by insurers that are generally called group annuity contracts (or policies). Under legislation that applies to insurance policies, every policy (including group contracts) must contain an element of insurance. In group annuity policies, the insurance element is a guaranteed minimum annuity purchase rate. This rate defines the benefit level that will be paid in respect of the account balance on commencement of an annuity under the contract.

As an example, the minimum rate in a policy issued to one of my clients less than five years ago is expressed as a dollar value for each $1,000 of the account balance at the date of commencement of annuity (with no reference to age) for the lifetime of the member and guaranteed for 10 years in any event. Thus, this rate is applicable for the earliest retirement age permissible under the plan—for most plans this would be age 55. Other policies specify an actuarial basis for determining the minimum pension amount, including the discount rate and mortality table.

Insurers deliberately set the annuity rates to be quite low relative to the market annuity rates at the time of issue of the policy. However, this does not mean that such minimum rates don’t have much value. In fact, the minimum annuity rate basis for a policy issued in the 1990s is likely to provide annuities at a significant premium to current market rates. As an example, for a policy issued to one of my clients in 1998, that rate basis provided for a 4% per annum discount rate with mortality rates that discount more heavily than current mortality rates. A minimum annuity under such a policy would provide much higher monthly pension values than current market rates.

Even if minimum guaranteed annuity rates are less than current market rates, there is also likely to be value for many in the underlying security of knowing that there is a defined minimum amount. Although uncertainty still exists around what the DC account balance might be at the time of annuitization, this is not much different than the level of uncertainty around the final salary amount on which many DB pensions are calculated.

This brings us to the issue of disclosure. Insurers do not transparently provide minimum annuity information to plan members or to plan sponsors. The information is not routinely provided on regular periodic (at least annual) statements provided to members or included in member information booklets, and it is not included in statements on termination, death or retirement. This lack of disclosure may represent a fiduciary risk to both plan sponsors and insurers, particularly if there have been any changes made to the guaranteed minimum rate basis, arising from a contract amendment or a switch in insurers, without due consideration of the potential value of the annuity guarantee.

Plan sponsors would be well advised to review the guaranteed minimum annuity rate basis with their insurance provider to determine whether routine disclosure on periodic members’ statements and termination/retirement/death statements should be provided.

Greg Hurst is a Vancouver-based pension consultant with Greg Hurst & Associates Ltd.

These are the views of the author and not necessarily those of Benefits Canada.

Copyright © 2018 Transcontinental Media G.P. Originally published on benefitscanada.com

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