Defined benefit pension plans naturally carry a number of risks, from fluctuating interest rates and investments to the lifespan of their plan members.
To mitigate those risks, DB plan sponsors are frequently turning to bulk annuity purchases, says Brent Simmons, head of DB solutions at Sun Life Financial. “Funded levels have been on a roller-coaster ride and plan sponsors have had lots of surprises, such as putting additional cash contributions into the plan. Most plan sponsors these days are considering two main routes — ‘Do I continue to manage this pension risk or do I transfer pension risk to someone else?’ Annuities match liabilities perfectly.”
While Canadian DB plans may be embracing this approach more strongly than their U.S. counterparts, both countries are still behind the U.K., where bulk annuity purchases have surged in popularity.
Longevity risk an increasing concern
In recent years, Canadian DB plan sponsors have increased their focus on risk management and, while investment risk may be their biggest concern, longevity risk isn’t far behind, says Simmons.
“Over the last 40 years, the assumptions that a typical pension plan has been using to estimate how long their plan members are going to live have changed a number of times. The result has been, for a typical pension plan, a 25 to 30 per cent increase in liabilities.”
Two examples of Canadian DB pension plans transferring their longevity risk through annuity buy-ins are BCE Inc.’s $5-billion transfer to Sun Life in 2015, followed by a $35-million transaction between Canadian Bank Note Co. Ltd. and the Canada Life Assurance Co. in 2016.
Under current Canadian legislation, DB plans seeking to transfer longevity risk are required to purchase annuities directly from an insurance company, a factor that may contribute to the relatively low number of purchases, says Marco Dickner, retirement risk management leader for Canada at Willis Towers Watson.
“You can’t deal directly with a reinsurer. After that, if you want to convert longevity insurance into a full annuity buyout, it could be challenging. It’s easier in the U.K. to make that transition. What we’ve seen is they purchase a longevity swap and a few years later they convert that to a buyout. That has never happened in Canada.”
How the U.K., U.S. compare
Like many other DB plans in the U.K., the Co-operative Pension Scheme has continually de-risked as it’s matured, says James Giles, the plan’s pensions investment and risk manager.
“We sold a lot of our growth assets. We sold our equities in 2016 and hedged our interest rate and inflation risk. The only big risk we’re running is longevity, so we’re focused on getting rid of it.”
The U.K. market saw a significant increase in annuity purchases in 2018 and 2019 as prices became more attractive to DB plan sponsors. In 2020 alone, the Co-operative Pension Scheme made two annuity buy-ins with Aviva, valued at £350 million and £1 billion, respectively. Similarly, U.K. retailer Marks & Spencer Group’s pension plan completed a £400-million annuity buy-in with the insurer, which followed a £925-million transaction in May 2018.
While the coronavirus pandemic caused U.K. annuity purchases to dip slightly in 2020, Giles expects the market to rebound to full strength in the near future. “There’s a bit of concern around how long it’ll take for the economy to recover from the pandemic, but I think once things are settled down, it’ll get back to where it was. Schemes are still mature and will be heading down that route.”
It’s a much different story in the U.S., where pension de-risking is less common than in Canada and the U.K., says Dickner. “In the U.S., when plans want to reduce risk they take care of interest rate, equity and longevity all at once. In Canada, we see that some sponsors are quite de-risked and invest significantly in fixed income, with little exposure to equity and interest rate risk. Often, those are the ones we see transacting [annuities].”
Though U.S. pension plans have been slow to embrace the option, the last decade has seen a couple of high-profile transactions. In 2012, both General Motors Inc. and Verizon Wireless transferred pension risk through a pair of annuity buyouts, valued at US$26 billion and US$7.5 billion, respectively.
U.S. plans may also consider annuity purchases to avoid paying premiums to the Pension Benefit Guaranty Corporation, a U.S. government agency that takes responsibility for a plan in the event of a bankruptcy. The PBGC took over J.C. Penney Co.’s DB pension after the company filed for bankruptcy last May.
While annuity purchases are more common in the U.K. than in North America, Dickner says all markets display a deep trend toward transferring risk, which will likely increase the number of these transactions in the coming years.
And in Canada specifically, the increase in annuity purchases over the last four years is evidence that DB plans will surely continue on this route, notes Simmons. “In 2016, the market was $2.7 billion. In 2019, it was $5.2 billion. The market has almost doubled in three years, which works out to an approximately 24 per cent year-over-year growth for the last three years.
“I’d be hard-pressed to find another market that’s growing at that rate.”
Blake Wolfe is an associate editor at Benefits Canada.