In a letter to the tax branch of the Department of Finance, the Association of Canadian Pension Management said it would be reasonable for certain large defined contribution pension plans to be issuers of advanced life deferred annuities.
According to the current Income Tax Act, only a licensed annuity provider can issue an ALDA. However, the ACPM said a number of large DC plans have successfully provided lifetime income solutions paid directly through the plan and suggested they could be suitable issuers of these annuity arrangements.
The letter also recommended certain changes to the government’s proposed legislation on variable payment life annuities. The legislation proposes that the amount payable to each member or beneficiary of a VPLA must be adjusted yearly, at least if the annuity’s fund rate is materially different from the actuarial assumptions used to determine the VPLA benefits.
Since there are already several scenarios where DC plans offer lifetime income solutions to retirees, the ACPM suggested the government consider their strategies when finalizing the legislation.
One option is a low-risk strategy with frequent adjustments is based on annuity rates and aims to provide a lifetime income with very low probability of reductions and infrequent increases. Its investment approach is very low risk, focusing on liability matching assets. Its approach to adjustments includes a margin folded into the pricing of the annuities to lower the probability of requiring a reduction. If a surplus exceeds a significant level, a modest pension increase is possible, but this isn’t the explicit goal of the strategy.
A slightly riskier strategy features more frequent adjustments, seeking to provide increases, on average, equal to inflation. It invests in a mix of stocks, bonds and alternatives, with the aim of achieving low to moderate risk. Similar to the low-risk strategy, it folds a margin into the annuity, lowering the risk of a reduction requirement and potentially resulting in a modest pension increase. With this strategy, however, margin and a provision for adverse deviation are formally written into the funding policy, which is made available to plan members before they agree to the option.
A third strategy features moderate risk with annual adjustments. Based on the long-term return assumptions of the fund rather that market annuity rates, it invests in a mix of stocks, bonds and alternatives with a risk budget allowing for 10 per cent fund volatility per year, the highest of the three strategies. As for adjustments, an actuary assesses the actual investment and mortality experience on an annual basis and determines whether it requires adjustments.
These three scenarios are examples of successful arrangements the ACPM is urging the Department of Finance to recognize and consider in its final decisions on the legislation.
“In particular, the legislation should allow each DC [pension plan] or [pooled retirement pension plan] offering a VPLA to develop its own funding and investment policies and communications to retirees about the objectives of the VPLA and the likely frequency of upward and downward adjustments to lifetime incomes,” the letter said.