With a defined benefit plan closed since 1991, Husky Energy Inc. was facing a dilemma. It wanted to annuitize the plan but had active members still accruing benefits and wasn’t ready for a complete windup.
To the organization’s knowledge, no products were available in Canada for plans to provide an annuity for active members still accruing benefits, says Steve Sproule, manager of health, benefits and retirement at Husky. “The current solutions didn’t work for us. We weren’t ready to declare a full windup and annuitize everything. And so our advisors and our research team said, ‘Here, these are your options,’ and the pension committee said, ‘Well, that’s not what we want.’”
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Not afraid to get creative, Husky worked with partners and regulators to find the right solution. During the process, it was suggested the company purchase buy-in annuities for its active members, says Sproule. “I do remember the feeling in the room . . . because eyes kind of popped and said, ‘Can we do that?’ And off we went to investigate it. And there was chat with regulators and you go through the process of researching it and seeing if it was actually doable. And fortunately it was.”
In 2017, Husky became the first plan — to its knowledge — to purchase annuities for active members still accruing benefits. It purchased $70 million of buy-in and buyout annuities from Sun Life Financial and $125 million of buyout annuities from the Bank of Montreal.
Buy-ins or buyouts?
Once a plan sponsor decides to take the annuities route, why do some opt for buy-ins while other choose buyouts?
Both options transfer the longevity and investment risk to the insurance company and both cost the same, says Marco Dickner, retirement risk management leader for Canada at Willis Towers Watson, who worked with Husky on the transactions. However, a buyout can be advantageous because it also transfers plan administration to the insurance company, he adds. But this may not be the right solution for every pension plan.
Indeed, Benoit Labrosse, Morneau Shepell Ltd.’s vice-president of asset and risk management, says plan administration alone isn’t enough to influence plan sponsors to purchase a buyout. “The real reason is to get rid of that financial, or fiduciary, responsibility for the people they transact on their behalf. And if they cannot get rid of that, then I don’t think the buyout offers any kind of significant advantage for a company or they should proceed with a buy-in.”
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For instance, a plan that isn’t ready for a full closure may choose a buy-in instead of a buyout to avoid triggering a windup, says Brent Simmons, senior managing director and head of DB solutions at Sun Life. While legislation varies by jurisdiction, he adds, some regulators can force a windup if there are no longer active members in a plan.
A buyout may also trigger certain settlement accounting rules that can affect a company’s earnings report and be noisy for investors. “Some pension plans would say, ‘We don’t want all that noise in our earnings per share results, in our financial results, so we’re going to delay the buyout until maybe we can better educate our investors or those amounts are smaller in the future,’” says Simmons.
As for buy-ins, they can be a good tool for plans that aren’t fully funded because a plan that’s underfunded at the time of a buyout would have to make cash contributions to close the gap, says Labrosse.
Timing and risk
The traditional approach to an annuitization is declaring a plan windup, receiving regulatory approval and, once approved, purchasing buyout annuities, says Dickner. However, issues with this approach include the short window for the transaction once the windup is approved and the fact the market may offer attractive opportunities ahead of time, he adds. As a way around these issues, plan sponsors can begin annuitizing inactive members prior to windup or in the process of declaring a windup.
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Husky took this a step further by also annuitizing active members with future liabilities. “Management of Husky really liked the idea of knowing the price of the entire transaction ahead of time instead of waiting until the windup was being approved,” says Dickner. “Knowing the price [of the] transaction as early as possible was very appealing for them.”
Some pension plans looking to purchase annuities could be worried about boomerang risk, which is the risk that when a plan sponsor buys an annuity from an insurer that later ends up in financial trouble, the responsibility for the plan transfers back to the organization.
Definitions
Buy-in annuity: An insurer makes payments to the pension fund and the plan sponsor pays the members. This is similar to any other investment held by the plan.
Buyout annuity: The insurer takes on the administration of the plan and pays the retirees directly.
While legislation is gradually changing across Canada, only British Columbia and Quebec have eliminated boomerang risk, while Alberta, Ontario, Nova Scotia and the federal regulator are moving in that direction. Some employers have delayed annuity buyouts until those rules came into play, says Simmons.
Where pension plans can’t take full advantage of a legislative discharge, it may not be advantageous to purchase a buyout, says Labrosse. The beauty of a buy-in, he adds, is a plan sponsor can hold this type of contract for many years and then convert to a buyout at no cost when legislative changes take effect.
More seamless for members
While it’s possible to purchase a buyout for active members, in cases where employees are still working and accruing benefits, it’s more seamless to choose a buy-in because it’s treated like a plan investment and wouldn’t be visible to members, says Simmons.
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Also, tax issues can arise for members if a buyout annuity is purchased without a crystalized benefit and the annuity turns out to be bigger than the pension payable at the end of the process, he notes. “When there’s that uncertainty around how much the benefit should be, if you accidentally buy too much, there can be these negative tax consequences. So [it’s] easier to do the annuity buy-in because it’s not attributable to any particular member and then you can, in the background, true it up later.”
For Husky, the buyout for non-active members and a buy-in as an interim solution for active members still accruing benefits occurred in 2017. It formally wound up the plan effective Dec. 31, 2018. And the buy-in will be converted to a buyout for the remaining active members this year.
Yaelle Gang is editor of the Canadian Investment Review.