Outsourcing pension risk through group annuity purchases
Group annuity purchases have been in the headlines a lot lately and rightfully so. Group annuity purchases have always been an option for plan sponsors looking to de-risk their defined benefit pension plan. With many pension plans returning to fully funded status, this once-costly option looks a lot more attractive today.
Related article: What you need to know about annuities
Canada recently saw its largest group annuity purchase in history, when an unidentified company purchased $500 million of annuities from insurer Industrial Alliance. Group annuity purchases have never been a popular option for plan sponsors in Canada, but this one blockbuster deal has suddenly been them on the map.
Pension buy-out vs. buy-in
Not all group annuity purchases are created equal. When looking to shift risk off a plan sponsor’s balance sheet, there are two main options.
When you think of group annuity purchases in the context of pensions, pension buy-outs are most likely to come to mind first. In a traditional pension buy-out, pension plan assets and liabilities are transferred to the insurer in exchange for an upfront fee. The insurer then bears the responsible for making pension payments directly to retirees, assuming the longevity and investment risk inherent in offering a defined benefit pension plan.
Although buy-ins have been around for years, it’s only recently that plan sponsors have actually pulled the trigger. Pension buy-ins share a lot of the similarities with buy-outs – longevity and investment risk is shifted from plan sponsors to insurers. The key difference is how the deals are structured – in a buy-out, the assets and liabilities obligations are transferred to the insurer, but in a buy-in the assets and liabilities obligations remain with the plan sponsor.
Timing is key
If you’re a plan sponsor and your pension plan has recently returned to fully funded status, now may be the opportune time to consider annuities. When you purchase an annuity, you provide the insurer with a large sum of cash up front in exchange for assuming risk.
Related article: De-risking your pension plan
The dilemmas faced by plan sponsors are similar to those faced by retirees: should I purchase an annuity today or wait until tomorrow? Interest rates may be low today, but as the Canadian economy continues to show signs up life, they could be soon be on the rise. Fixed income isn’t a plan sponsors only concern – by purchasing a group annuity today, you could miss out on a bull market again this year like we saw in 2013.
Group annuity purchases pick up steam
2013 was a banner year for group annuity purchases for ongoing pension plans. Annuity purchases hit $1.2 billion in 2013, after being a blip on the radar in 2012 and 2011. While annuities have been widespread in the U.S. and the U.K. for decades, Canadian firms have been slow to embrace annuities.
With pension health improving, this could soon change. Canadian plan sponsors have a distinct advantage over pension plans in the U.S. and the U.K. – relatively few Canadian pension plans in the private sector offering indexing in retirement, making annuities an attractive and less costly option.
The pitfalls of annuities
Group annuity purchases aren’t necessarily a great option for all plan sponsors. If your pension plan remains underfunded, it can be a very costly option. The pension deficit will have to be made up from somewhere – those plans for expansion may have to take a backseat if you decide to de-risk today. Annuity purchases make the most sense for large companies with hundreds of retirees; if you’re a smaller plan sponsor, it may not make sense from a dollars and cents perspective to purchase group annuities.