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Why De-Risk?

Many DB plan sponsors have decided that their defined benefit obligations are unsustainable. As a result they are looking for approaches to opportunistically reduce risk over a time horizon appropriate for their financial constraints and workforce arrangements.

Each DB plan sponsor will have a very specific set of plan provisions, financial constraints and workforce considerations to contend with and therefore will require a highly customized de-risking solution.

Important de-risking considerations are…

  1. View asset risk in relation to liabilities rather than in isolation. Matching interest rate sensitivities of assets and liabilities is a key de-risking consideration.
  2. With many pension plans in Canada and the United States committed to exiting their DB obligations, there will be a growing demand for de-risking. Therefore, as interest rates increase and solvency ratios improve, many companies will move aggressively to purchase long term bonds.
  3. Canadians are living longer.While this is extremely positive for our society, it has real costs to DB pension plan sponsors. Therefore growing longevity risks should not be ignored.

Some potential de-risking approaches to consider

  1. The first step to de-risking is often to commit new contributions to fixed income instruments with longer durations to reduce interest rate risk mismatches between assets and liabilities.
  2. Step two is often to establish a glidepath of trigger points which opportunistically captures gains to the plan in-terms of solvency ratio improvements as the plan moves towards fully funded status. These improvements allow the plan to capture and lock-in the benefit of any interest rate increases or equity value improvements.
  3. Step three is often to start to eliminate longevity risk through gradual purchases of group annuities. The Group Annuity Buy-In (pending approval by FSCO and OSFI) will allow plan sponsors to off load risks to an insurance company without needing to immediately fund any related liability deficits.

De-Risking Pros

  1. De-Risking opportunistically captures and locks-in gains in the solvency ratio.
  2. De-Risking reduces the variability of funding requirements and variability of financial statement impacts
  3. A pre-set de-risking glidepath with pre-set trigger points alleviates demands on the decision making committee.
  4. A pre-set de-risking glidepath also has the benefit of dollar cost averaging the transition to an immunized portfolio which reduces the risk of being forced to execute under un-conducive conditions.

De-Risking Cons

  1. There is a cost to moving gradually towards a fixed income portfolio in terms of lost risk-premium as equities may outperform fixed income in the time horizon of de-risking.
  2. Sustained interest rate increases would favour a short duration of the assets and a long duration of the liabilities. Most de-risking glidepaths gradually move toward the elimination of this mismatch in durations between assets and liabilities.
  3. Group annuity purchases have a cost.

To smoothly manage de-risking, you need a partner you can trust. Industrial Alliance is a leader in de-risking expertise and can support you with completely customized de-risking glide paths and a wide range of leading investment fund managers to choose from in customizing your de-risking solution!