Two Canadian pension plans are teaming up to buy about $530-million of annuities in a creative deal to transfer investment, inflation and life-expectancy risk to an insurance company.
Sun Life Financial Inc. sold this joint annuity contract to two previously unrelated defined-benefit pension plans, whose sponsor companies did not want to be identified. The annuity is an investment that matches up with the pension plans' liabilities to reduce risk for the sponsors. The advantage of banding together and doing the transaction at the same time was more than $20-million in savings.
The deal comes as pension plans are wrestling with many risks, including shaky markets, persistent low interest rates and uncertainty about inflation and how long pensioners will survive. Some plans are turning to new asset classes to boost returns, and some are exploring new ways to ratchet down risk.
The idea for Sun Life's latest arrangement, which is the first of its kind in Canada, came after the insurer began discussion with both companies separately in early 2015, and the insurer noticed that the pension plans had different inflation formulas. "One plan sponsor promised to increase benefits when inflation was low. The other promised to increase benefits when inflation was high," said Brent Simmons, senior managing director for defined-benefits at Sun Life, adding that both promises are tricky to buy proper asset management strategies for.
Sun Life saw an opportunity to put them together to "smooth out that inflation exposure … and, as a result, it's much easier to create an asset portfolio to protect ourselves against that particular risk," Mr. Simmons said.
This type of "annuity buy-in" deal involves the plans together paying one lump-sum premium to Sun Life to transfer their investment, longevity and inflation risk. It does not transfer the responsibility to pay pensions from the sponsor to the insurer. As Sun Life describes it, the annuity "can increase benefit security by allowing the pension plan to better match its assets with the pension promises it has made."
Annuities for pension plans are part of a strategy known, in industry parlance, as "pension de-risking." These sorts of transactions became commonplace in the United States several years ago, and Britain has also been a leader with £19-billion ($38-billion) in de-risking deals last year. Canada's market is still developing, and Sun Life has actively been focused on building business in this space for several years.
Two significant de-risking annuity deals in Canada were a $150-million deal by the Canadian Wheat Board in 2013 and a $500-million deal with an unnamed Canadian company done by Industrial Alliance Insurance and Financial Services Inc. last year.
The fact that some companies are unwilling to disclose their involvement could indicate they would prefer their members and pensioners not be made aware of the move to shift risk to an insurer.
But Sun Life said the way sponsors are thinking about their plans is evolving. "Historically, plan sponsors have always thought of their plans as places to make calls on equity markets and interest rates. The change of philosophy we're seeing is plan sponsors now looking at their pension plans and seeing a place where, first and foremost, they want to generate benefit security for their plan members," Mr. Simmons said.
"What that means is taking a much safer and more prudent approach to risk management."
Mr. Simmons estimates there will be transactions as large as $1-billion coming to market in the next few years, based on conversations with pension plan sponsors.
Theoretically, as much as $600-billion in Canadian defined benefit pension plan assets and liabilities could shift from plan sponsors to Canadian insurers through annuity deals, Tom MacKinnon, an analyst at BMO Nesbitt Burns Inc., said in a note to clients. But this would "clearly take a long time," he noted.
Some other companies also see this as a growing area. Last week, Royal Bank of Canada sold part of its insurance business and the company said it would dedicate more time to other initiatives, including pension plan de-risking for small- and medium-sized pension sponsors.
"In other parts of the world, it has become an important part of pension plan management," said Neil Skelding, chief executive officer of RBC Insurance. He is seeking pension plans studying their longevity risk – the likelihood pensioners may live longer than projected – which can mean that the amount paid out to them is higher than expected.
That is the type of deal that BCE Inc. struck with Sun Life last March. The telecom giant paid to "lock in" the life expectancies of a block of pensioners where all payments owed to them were valued at $5-billion, based on actuarial assumptions. Combined with about $2.5-billion in group annuities sold, Canada's de-risking market was at its largest in 2015 at $7.5-billion.