The strength of equities was among the factors pushing the transaction volume of Canada’s group annuities market to a record high in 2021, according to experts.
According to a recent report by LifeWorks Inc., the total volume of group annuities sold in Canada reached $7.5 billion in 2021, up 70 per cent from the previous year. Figures provided by Sun Life Financial Inc. showed an even sharper rise in the total transacted volume, pegging the 2021 figure at $7.7 billion.
In the third and fourth quarters of the year, transaction volumes hit $3 billion, noted LifeWorks’ report. Part of the reason for this increase is the strength of equity markets in the final half of the year. As equities rose, many defined benefit pension plan sponsors began executing de-risking strategies.
Véronique Lauzière, associate partner of investment and risk and innovation leader at LifeWorks, says DB plan sponsors sought to lock in gains. “Annuities can be the perfect investment. It can replace fixed income. . . . There’s increasing plan sponsor demand. It’s a solution for all shapes and forms of pension plan.”
Annuities de-risk pension funds by acting as fixed income investment and transferring the risk associated with those pension payments from the plan sponsor to the insurer. When a plan member lives a longer life than expected, it’s the insurer that pays for the difference.
In an email, Brent Simmons, head of DB solutions at Sun Life, noted annuities can also offer better yields than traditional fixed income. “It would be reasonable to expect that the yield on an annuity would be lower than the yield on a comparable fixed income portfolio to account for this risk transfer. Interestingly, the opposite is true.”
Plan sponsors with indexed DB pensions is one group that’s been less interested in annuities. “For the same dollar, it will cost you more than for the non-indexed pension,” says Lauzière. “That may change in an inflationary environment.”
Concerns about inflation are also playing a role in pushing plan sponsors toward the group annuities market, which offers inflation-linked products. During the long period of low inflation that preceded 2021, many plan sponsors eschewed these products.
However, there are signs that inflation-linked annuities are becoming more appealing to plan sponsors. Last year, as the consumer price index crept up, pension plan sponsors purchased about $600 million of inflation-linked annuities. “An inflationary environment increases the cost of not hedging, leading some plan sponsors to revisit their previous decisions,” said Simmons.
While the dramatic increase in group annuity transactions in 2021 may appear to be the result of recent changes to the economic status quo, both Lauzière and Simmons believe economic circumstance isn’t the only driving force.
Over the course of the past decade, insurers have improved their ability to handle large group annuity purchases. Even in 2020, a year that saw an overall decrease in group annuity purchases in Canada, the insurance industry was able to handle a record-breaking $1.8 billion transaction placed by General Motors of Canada Co.
“Historically, the largest pension plans were difficult to place,” says Lauzière. “Only a few years ago, it wasn’t a realistic thing to even think about annuities for a billion-dollar plan. Legislation now permits plans that are purchasing annuities to get a statutory discharge of liabilities.”
In essence, the new rules allow plan sponsors to disregard the risk of an insurer defaulting on annuities in their calculation of plan liabilities. According to Simmons, these legislative changes reflect the strength of Canada’s insurance sector.
“Canadian insurance companies are very well regulated and their core business is keeping promises to policyholders. In the unlikely event of a default, a statutory discharge prevents responsibility for paying the buyout annuity from reverting to the plan sponsor.”