Canadian pension plans are expected to face easier funding conditions in 2017 as interest rates stabilize, driving more plans to buy annuities to cover their funding obligations and invest in new financial instruments to hedge the risk of plan members living longer.
A 2017 pension forecast by consulting firm Mercer Canada anticipates big growth in annuity purchases, with Canadian pension plans forecast to buy $4-billion to $5-billion in annuity contracts in 2017, an increase from a record $3-billion in 2016 and $2.2-billion in 2015.
Pension plans buy annuity contracts from insurers, locking in the cost of providing pensions to plan members. Employers remain responsible for funding the plans, but the deals help insure the risk of future volatility in their investment portfolios.
Mercer senior partner Jean-Philippe Provost said interest rates are not expected to fall in 2017 and may rise further, which means plans should face stable-to-positive funding conditions for the year ahead as the economy grows. With plans moving closer to fully-funded status, Mr. Provost said it is easier for them to invest in financial instruments, such as annuities or longevity swaps, both of which reduce future funding risks.
"For the last couple of years, pension plans have had to deal with an environment where interest rates were going down, so even if rates are flat I think most pension sponsors will be happy with that," Mr. Provost said following Mercer's annual pension forecast event in Toronto. "At least it's not additional headwinds they have to deal with."
Pension plans saw their funding improve sharply in 2016, with average funding climbing to 95 per cent compared with 86 per cent a year earlier, largely a result of market gains and interest rate increases following Donald Trump's election in November.
Despite better funding, however, Mr. Provost said some pension plans are still unwilling to buy annuities while interest rates remain so low, but are interested in at least insuring against longevity risks, making longevity swaps a more attractive option for 2017. Longevity swaps are financial instruments that pension plans purchase from insurance companies, covering the risk of plan members living longer than estimated under pension plans' actuarial formulas.
"We're seeing a lot more interest from plan sponsors in regards to that," Mr. Provost said.
Canada has only seen few longevity swap deals, with BCE Inc. insuring $5-billion of liabilities in 2015 and Canadian Bank Note Co. insuring $35-million of longevity risk with Canada Life Assurance Co. in 2016. Under that deal, Canadian Bank Note is still responsible for its members' pensions, but Canada Life absorbs any unexpected longevity risk, and would reimburse Canada Bank Note if pensioners live longer than expected.
Britain-based Artemis, which tracks deals globally involving risk transfer and insurance products, said the Canadian Bank Note transaction was the smallest longevity swap it is aware of anywhere in the world, suggesting such deals are now affordable for a much smaller tier of pension plans.
Mr. Provost said longevity swaps were historically very complex to structure and price, but have become far simpler, making them available to a broader array of pension plan sponsors.
Among its other pension forecasts for 2017, Mercer said it anticipates more provinces and even the federal government to launch reviews to look at adopting new pension-fund rules similar to those adopted in Quebec in January, 2016. The new rules no longer require private-sector pension plan sponsors to fund plans on a solvency basis, which requires funding on the assumption a plan would be shut down immediately, but tightens funding rules based on the assumption a plan will continue to operate as a going concern.
Mr. Provost said Mercer's Quebec-based clients had an average 40-per-cent reduction in their pension contribution requirements under the new rules, which has led to pressure for change from companies operating in other provinces.