Did you know that as much as $75 billion of capital accumulation plan (CAP) assets in Canada are committed, albeit contingently, to life annuities? If this fact does not come as a surprise to you, consider yourself to be very well-informed about CAPs, as this may be one of the most closely kept secrets of the Canadian life insurance industry.
One of the most interesting things about this secret is that, like Waldo of the famous “Where’s Waldo” drawings, it is hidden in plain sight.
Most CAPs in Canada are administered under group policies or contracts are issued by life insurance companies. These arrangements are most commonly called “group annuity contracts” or “policies.”
In order to be a bona fide contract of group insurance, and therefore subject to insurance legislation (as opposed to securities rules), there must be provision in such contracts for insurance monies paid. The most common provision is that the policy will pay a life annuity according to a specified guaranteed minimum annuity rate basis. This can be found, in black and white, in the policy or in the “certificate of insurance” issued to members in respect of the policy.
You may be asking yourself, “So what?” Indeed.
To answer that question, the starting point lies in the two primary components of annuity pricing: the discount rate (or assumed future rate of return for assets backing the annuity) and the mortality table.
Typically minimum annuity rate basis guarantees are set to minimize risk for the insurer relating to changes in the discount and mortality rates. Ideally, from the insurers’ standpoint, the minimum guaranteed rate would never apply with market rates at the time of annuitization proving to be more favourable or other retirement income products more desirable. Thus the commitment of CAP assets to life annuities is of a contingent nature.
1. So what if the policy was issued in the 1990’s?
A common guaranteed minimum annuity rate basis at that time utilized a discount rate of 4% per annum and the group annuity mortality table for 1983. At that time, interest rates had been in steady decline, with a resulting steady increase in the cost of annuities, which then generally fell out of favour as a retirement income option with the public.
But fast forward to 2010. The guaranteed minimum annuity rate basis under a 1990’s contract will look much, much more attractive to those considering retirement now, delivering lifetime guaranteed retirement income at levels from 30% to 45% higher than current market annuity rates. Policies issued before the 1990’s will look even better!
2. So what about lifetime guaranteed minimum withdrawal benefit products now being launched by many insurers to a receptive marketplace?
Interest in products providing retirement income guarantees is clearly growing, and thus the fertile ground for these products. But, are they really necessary for group plans that already have annuity guarantees, particularly those in an older contract?
3. So what if the plan sponsor’s old contract has been updated or moved to another insurer with a new minimum rate basis guarantee that has current annuity market rates?
In such cases plan sponsors may wish to seek professional advice to consider potential legal liability risk exposures. Areas to be investigated might include what, if any, disclosure was made by the insurer concerning any changes to the guarantees, and whether the insurer made any material changes to pricing relative to any changes in guarantees.
4.So what are plan administrators telling those who are eligible for benefits about the guarantees?
Plan sponsors might check this with their plan administrators. Clearly, the existence of a very favourable annuity rate basis under a group plan would require disclosure for anyone who would be eligible for such benefits.
The fear is, some plan sponsors will find disclosure to be somewhat lacking in this area. If someone were to tell retiring plan members about it, it wouldn’t be a secret anymore, would it? The real question that needs answering is: Why is it?