How far are Canadian pension plans along on the path to de-risking? And what does the journey look like? Those were among the questions explored in a recent Benefits Canada pulse survey. As Canadian plan sponsors grapple with low interest rates, poor prospects for economic growth and heavy market volatility, what risks are keeping them up at night and how do they plan to deal with them?
We sent our questions to 168 of the top pension plans in Canada through the Canadian Institutional Investment Network. So what did we find? When it comes to de-risking, just over half (58.5 per cent) of those surveyed are considering de-risking their defined benefit pension plan. Not surprisingly, interest rates top the list of reasons to de-risk (66.7 per cent), followed by market volatility (54.9 per cent), low returns (52.9 per cent) and longevity (29.4 per cent).
The vast majority (82.4 per cent) say they’re most likely to use liability-driven investing, with far fewer leaning toward annuities (19.6 per cent) or pension buyouts (13.7 per cent). That lower number could reflect respondents’ perceptions about annuities, with 78.4 per cent saying they’re too expensive and another 45.1 per cent noting their plans aren’t at fully funded status.
Knowledge levels about annuities remain low, however. Less than 10 per cent of respondents would rate their knowledge of annuities as excellent, the survey found.
Overall, the research shows a division among plan sponsors on the benefits and costs of different de-risking approaches, a situation that may reflect a lack of understanding of what the options involve. The majority of the plans surveyed would consider liability-driven investment, with many of them suggesting annuities are more expensive. That’s not necessarily true, however. Zev Frishman, chief investment officer at Morneau Shepell Asset and Risk Management Ltd., says plan sponsors need to understand the trade-offs.
“Annuities are expensive,” he says, noting that’s also true for liability-driven investment.
“You lock in your returns in investment-grade bonds and you’re in negative territory in real terms for most of the yield curve,” he says. “If you go very long, you’re a match with liabilities but you are taking a big risk on the asset side.” The bigger threat is not being able to generate enough returns to pay benefits, he adds.
Where Frishman does see things improving is on the regulatory side. Quebec has already eased solvency requirements for defined benefit pension plans, and Ontario and some other provinces are considering following suit. When that happens, he notes, it should significantly reduce the number of pension funds having to de-risk.
At the Goodyear Canada Inc. pension plan, the de-risking journey is already well underway. Thak Bhola, manager of pension, investments and administration at Goodyear Canada, says the company’s de-risking program began in 2006. He notes that with annuity purchases putting a particular plan in a surplus position, the company is now looking at other plans. “We have completed our de-risking journey. All we have to do now is start to look at annuity purchases,” he says.
Right now, the company is looking for a good rate and to establish triggers for annuity purchases. The key for companies looking to annuitize is to maintain a state of readiness for when it comes time to make the purchase. “You have to have your data clean and everything signed off by the appropriate stakeholders,” he says.
When it comes to plan sponsors’ perceptions of annuities, Brent Simmons, senior managing director for defined benefit solutions at Sun Life Financial, says he hears a lot of misconceptions about them in the marketplace and he notes there are many ways to use them, even when a plan isn’t at fully funded status or remains open to new members. As for cost, he says it depends on what the plan sponsor is comparing it to. In many cases, annuities offer a higher yield than a pension plan’s generic bond investments, which means they can provide a transfer of longevity and investment risk for free.
And when it comes to other strategies available to plan sponsors, Simmons says that for those looking at liability-matching strategies, interest rates would have to rise by more than 250 basis points over the next five years for liability-driven investing to be a bad investment decision.
“Now, people are talking about low for long, and there are negative rates in parts of Europe and Japan,” he says of the current environment of low interest rates.
“Suddenly, that 2.5 per cent hurdle seems pretty high, making LDI an attractive option.”
Caroline Cakebread is the editor of Canadian Investment Review.
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