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Joe Hornyak
Former editor of Benefits and Pensions Monitor and founder of Joe Hornyak Communications
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Super-priority could push plans to annuities
Bill C-228, Canada’s pension super-priority bill, is likely to give defined benefit plan sponsors the final push to proceed with a strategic annuity purchase, says Ryan Kastner, chief business development officer at Brookfield Annuity Company. He told the Club Vita ‘Bill C-228 ‒ Canada’s pension super-priority bill: Implications and potential risk management strategies for DB plan sponsors’ webinar it could also prompt sponsors to exit DB plans entirely.
Currently, the reason plan sponsors purchase annuities is “because they have to,” he said. When a plan terminates, annuities are purchased for the members who are receiving benefits or have elected to receive benefits in the future as part of this wind up.
However, plans also consider annuity purchases for risk mitigation. “The unprecedented bull equity markets since the great recession left many plans sponsors fully funded. The ability to lock in that surplus has been a contributor to transactions over the past five to 10 years,” he said.
This focus on risk management has been further exacerbated by the maturation of plans that have been closed for 10 to 15 years. Plan liabilities are becoming more and more skewed towards retirees and older people. “Not only does that tip the scales towards annuities, but it also adds strain on the administrative requirements in place and further encourages the offloading of liabilities because you can transfer away the administrative burden associated with that,” said Kastner.
However, there is also anecdotal evidence that a legislative change may prompt more plans to annuitize. Around 2016, there was the introduction by several jurisdictions of the concept of a discharge liability. This allowed plan sponsors that met certain conditions to legally sever the connection between the plan member and the plan via an annuity purchase. This “certainly provided additional tailwinds to purchasing annuities,” he said.
With Bill C-228, there will be a four-year transition period, at which point pension plan liabilities will take priority over other creditors upon sponsor insolvency. For organizations and associations who rely on external financing to support their daily operations in any shape or form, their cost of borrowing is likely to increase materially because creditors are going to get “bumped down the food chain or the pecking order. Annuities, because they serve as the most streamlined and immediate solution to reducing or even eliminating the pension liability, will reduce this risk,” he said.
This means, at the very least, it will lead to a reevaluation of the position of annuities in the risk management toolbox of plan sponsors.
The actual number of insolvencies at companies with DB plans between 2009 and 2022 was only 10, said Susan Nickerson, a partner at McCarthy Tétrault.
Despite the small number, for plan sponsors just looking to terminate a DB plan in response to Bill C-228, the timing can be hard to predict and it can take some time.
The bill will not take effect until April 27, 2027, giving existing DB plans four years to respond. “So to the extent that a plan sponsor is being forced or feels it's expected to terminate a DB plan, they have to think about how much time it will take because four years can go by quickly,” she said. This is especially the case when employers must give employees’ notice since pension benefits are a major term of employment and any change could be a material change and result in constructive dismissal. If there are unionized employees, union approvals may be required.
Plus there's the timeframe to go through all the regulatory steps for a pension plan windup. “If there are a number of plan sponsors that have the same view to terminate their plans, then the regulators in Canada will have an inordinately large load of windups to process and that could slow things down,” she said.
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Annuity purchases in the context of a windup can also take a “fair amount of time.”
To mitigate risk now, Nickerson said plan sponsors should look at the funding, investment, and risk management strategies to see if they can improve the plan’s funded position or ensure the plan is fully funded. If they are purchasing an annuity, they also need to ensure the pension plan text and the investment policies permit it.
They also need to prepare the data required for an annuity purchase and then determine if there's any other approvals required in order to implement a conversion or windup
Alexandre Sonnenwith, client delivery officer at Club Vita, said the data provided by plan sponsors can have a big impact on the cost of annuitizing.
Data preparation and understanding a plan’s longevity profile and mortality risk are important considerations in setting group annuity premiums. Meanwhile, “understanding the plan’s longevity is only as good as the data,” she said. “A good way to ensure your data is credible is to perform validation checks and enhance the data where there are gaps and filter it where it looks a bit more wonky.”
Plan administrators should also conduct survival audits for all inactive members, retirees, beneficiaries, and deferred vested as well as locate missing members. “This can help prevent the purchase of annuities for deceased individuals or retirees with deceased spouses.”
To calculate baseline longevity, a top down approach which compares data from a similar plan to the sponsor’s can be used.
However, insurers take a more granular approach and up a bottom up approach. This calculates the longevity for individuals based on their different characteristics. This can help close the gap between a plan’s longevity assumptions and the insurer’s. “Agreeing on baseline mortality means one less unknown is built into pricing and, in theory, more consistent insurer pricing,” she said.
The steps that plan sponsors can take to level the playing field with insurers and secure optimal pricing start with scrubbing a plan’s data thoroughly and this is “probably where plan sponsors have the most control and it will result in direct price savings,” said Sonnenwith.
For details on these stories, visit www.bpmmagazine.com