Calculated Risk

For instance, insurance companies have to fund their pension commitments (i.e., annuities) very differently from the way a plan sponsor would. They must maintain a surplus at all times through contingency reserves. In contrast, many company-sponsored pension plans have substantial deficits that are only gradually being addressed.

What if the insurer goes bankrupt? These odds should be considered relative to the chance that the plan sponsor will go bankrupt. In the U.K., insurers are subject to an annual valuation (reviewed by the Financial Services Authority) and to the Financial Services Compensation Scheme, which is generally more comprehensive than the PPF. A similar regulatory structure exists in Canada, so the same considerations will apply when contemplating transferring pension obligations to an insurance company.

A Canadian Opportunity?
The practice of buying annuities to discharge pension liabilities has been an option in Canada for decades. However, it is now gaining popularity as the same factors that drove the U.K. market become more prominent in Canada. For some organizations, this will essentially mean coming full circle: many plans started out as group annuity contracts that were brought in-house in the 1970s due to dissatisfaction with insurers.

Some DB plan sponsors will undoubtedly find it an attractive option. However, one challenge may be affordability. Pension plans in North America have generally experienced the same investment losses as those in the U.K., so many can’t afford to buy annuities now—despite the fact that annuity rates are favourable.

If a plan is only 70% funded and it buys an annuity for pensioners, then the funded ratio for the remaining plan members will drop below 70% after the premium is paid. Pension regulators generally won’t allow this type of transaction unless the sponsor commits to contributing enough to boost the plan’s funded ratio back up to 70%—which, in the current economy, plan sponsors will be loath to do. This may make buy-in strategies more common in the short term until plans’ funded positions improve.

Hewitt Associates’ Global Pension Risk survey, conducted last year, found that Canadian plan sponsors are generally behind their global counterparts when it comes to managing pension risk. This is perhaps surprising, as Canada stood out as the region where DB plan closures to new employees were less prevalent—which leaves Canadian employers more at risk to the changing financial and regulatory environment than many of their non-Canadian counterparts.

As more Canadian plan sponsors start to actively measure those risks—and as Canada moves to international accounting standards in 2011—options such as buyout arrangements to manage or transfer risk will receive more attention.

In Canada, as in the U.K., the size of the group annuity market is relatively small compared to the size of private sector pension plans. New players are likely to emerge, including traditional insurance companies and other financial institutions. Some Canadian insurers are already active in the U.K. and are positioning themselves to take advantage of the Canadian buyout market once the financial positions of pension plans start to improve.

Plan sponsors interested in taking advantage of buyout opportunities can start planning now by cleaning their data, reviewing their investment strategies and considering any issues with their benefits structure. When conditions improve, these organizations will be better positioned to quickly take advantage of such opportunities as they arise.

Rob Vandersanden is a senior retirement consultant with Hewitt Associates in Calgary and a member of Hewitt’s global pension risk team. William da Silva is Hewitt Canada’s retirement practice leader, based in Toronto.
rob.vandersanden@hewitt.com
william.da.silva@hewitt.com

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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the May 2009 edition of BENEFITS CANADA magazine.