Canadian annuity prices have an asymmetrical response to changing interest rates, making it more expensive to de-risk defined benefit pension plans shortly after rates rise, according to new research.
“In Canada, annuity providers are prompt when it comes to raising prices when interest rates go down and slower when interest rates go up,” says Mark Kamstra, professor of finance at York University’s Schulich School of Business. “That’s bad for buyers.”
The research, conducted alongside Narat Charupat, professor of finance at McMaster University’s DeGroote School of Business, is part of a broader collaboration to study the efficiency of the Canadian annuity market. “That’s our big picture,” says Kamstra. “The problem is it requires us to make a lot of assumptions. The idea [behind focusing on annuity price changes following interest rate shifts] was to look at something smaller and with fewer assumptions.”
The findings, which were revealed in an article published in the Journal of Pension Economics and Finance, showed a stark difference between the way the annuity market operates in Canada and in the U.S. “[In the U.S.], annuity providers generally respond faster when interest rates rise and slower when they go down,” says Kamstra.
This difference can be explained by looking at the number of annuity providers operating in each country, he adds. “In the U.S., there’s a lot of smaller ones that tend to change rates more aggressively to protect market shares.”
While de-risking through U.S. providers may offer a price advantage, Kamstra believes DB plan sponsors have other reasons to favour the Canadian annuity market. “The most important thing about an annuity is faith and confidence. It’s a long contract and, in Canada, we have large, stable companies that have good oversight and are pretty conservative. What we’ve identified aren’t gigantic examples of unfavourable treatment.”