Defined benefit pension plans that were on route to de-risking when the coronavirus hit are facing a difficult road ahead in the current lower-for-longer interest rate environment.
However, a new de-risking option is available for plan sponsors that didn’t exist in the wake of the global financial crisis: merging with the Colleges of Applied Arts and Technology pension plan.
Under the CAAT’s DBplus offering, which launched in 2018, employers can transfer past liabilities over to the CAAT pension plan, taking them off their own balance sheets. They can also choose to join on a go-forward basis for future benefits.
“Many plans that we’ve been working with who started the de-risking journey hadn’t completed it and fixed income was really the path for a lot of them, before perhaps setting it up for an annuity purchase or just keeping it on their books, but trying to remove the volatility,” says Derek Dobson, chief executive officer and plan manager at the CAAT plan. “But clearly, in a near-zero interest rate environment, bonds might remove the volatility, but are becoming so prohibitively expensive as a longer-term strategy on those who are on a path to de-risking. The challenges are mounting to do this in a very cost-effective way.”
During the first 12 weeks of the pandemic, employers were focused on keeping their businesses up and running remotely, but since that initial period, the CAAT has seen an increase in plan sponsors looking at CAAT as a de-risking option, he says.
Its DBplus option is a cost-effective option because the organization prices mergers to be cost-neutral to the CAAT plan, says Dobson, noting it essentially uses the present value of future expected returns for the CAAT portfolio as the expected basis for groups to join. “Since our investment outlook has changed a little bit — but not at the same drastic pace as the bond market, as an example — our solutions have become even more attractive than they were in the past.”
Further, plans joining DBplus don’t need to fund windup liabilities at historically low interest rates.
As an example, he highlights Torstar Corp., which merged eight DB plans with the CAAT plan in 2019. “The pension liabilities that they were managing on their own were around $1.2 billion. We priced them [on a going concern basis] to come into our plan at about $900 [million] more or less, so they didn’t have to put a penny in for the de-risking solution. They also got benefit enhancements for their members on providing inflation protection, which was critically important as well and they got it off their books.”
Removing pension liabilities from a corporation’s books is important in merger and acquisition situations, adds Dobson, noting that, after de-risking through the CAAT plan, Torstar was acquired by a private equity firm.
While plan sponsors are joining DBplus for different reasons, those motivated by financial de-risking make up about 40 per cent of the groups that have joined to date, accounting for about 70 per cent of the new membership, he says.
Further, some are joining while they have a solvency deficit. In these situations, the organization will allow a fixed amortization schedule to fund the shortfall, so the volatility is removed and employers can de-risk immediately rather than waiting for an increase in interest rates.
The demand for de-risking solutions is clear, with new annuity purchase records set every year. And joining CAAT is an alternative to some of the more traditional paths because it can allow plan sponsors to de-risk past and future benefits and still offer retirement benefits on a go-forward basis, Dobson says.
“I think we’ve filled a big void in the marketplace for groups who wanted to do both a de-risking on a cost-effective basis, but also still be an employer of choice from an employee or labour relations perspective.”