Higher long-term bond yields driven by rising interest rates are lowering the cost of annuity purchases for defined benefit pension plans, says Mary Kate Archibald, a principal at Eckler Ltd.
Since January, the cost of an annuity purchase has decreased by between 10 and 15 per cent, as long-term bond yields increased from 1.7 to three per cent over the same period, she says, citing a new report by the consultancy.
And while equities markets have taken a significant hit in 2022, she notes there’s a good chance a pension plan sponsor’s liabilities have been more impacted than their assets, resulting in an improved solvency position that they may want to lock in.
“In terms of investment strategies, one of the quickest things plan sponsors can do is implement a hedged portfolio . . . such as a combination of long bonds, corporate bonds or shifting into a full bond portfolio with a better match to liabilities and then lock in that funded position on a solvency basis, buying time to execute the further pension risk transfer strategy, such as purchasing a buyout annuity. That can take months and, during that time, a lot of things can happen.”
A previous report by Eckler found the Canadian pension risk transfer market registered total annual sales of $7.7 billion in 2021, with $6.6 billion of those sales taking place in the second half of the year. It also noted $4.6 billion (60 per cent) of these transactions were classified as buy-ins rather than buyouts in 2021, the biggest dollar amount since the first buy-in transaction in Canada in 2009.
Archibald says it’s likely this trend will continue in 2022. “There’s pros and cons [to buy-ins] but they’re a form of investment for plans that are looking to de-risk but not fully wind up. . . . Buy-ins can be just as effective as buyouts when it comes to locking in that funded position and are sometimes quicker to execute.”