Longevity insurance goes small

Canadian Bank Note Co., an Ottawa-based security printer best known for producing the country’s banknotes, has become just the second entity in Canada to insure against so-called longevity risk for its pension plan.

But the company, which has been around since 1897, did create its own historical marker: With a mere 220 pensioners and $35 million of affected liabilities, the transaction, which transfers responsibility for excess payments that arise when pensioners live longer than expected from pension fund to an insurance company, is the smallest of its kind in the world. Given the complexity of such arrangements the norm is for large transactions, as demonstrated when Bell Canada completed a deal involving $5 billion of liabilities in March 2015.

Both transactions occurred because people, both here and abroad, are living longer, certainly longer than what actuaries are expecting — which means larger and longer pension fund payments.

“There is very little upside benefit from longevity,” said Bradley Baker, senior actuary at Canadian Bank Note. “Longevity risk is not (that) balanced. The downside risk is huge. When a pensioner lives much longer than expected, the impacts on the liabilities can be quite severe.”

“Longevity risk was the largest risk affecting our pension plan,” added Baker, who worked with Mercer, a pension-plan consulting firm, and Canada Life, the insurer that’s providing the longevity insurance, to structure the transaction. The discussions — about what Baker terms “a risk-mitigation strategy” — started about two years back but gathered pace over the last six months.

On a big-picture basis, longevity risk refers to the situation where a group of retires live longer than expected, according to the actuarial assumptions employed by the fund. Because of that, the fund is required to pay more than it planned to the retirees. Longevity insurance allows the plan sponsor to transfer that risk to the insurance company. In rough terms the fund makes the agreed-upon first 10 years of payments; after that the insurer makes the payments until the retirees pass on. “The amount of the savings will depend on how long our particular group of retirees live,” said Brady.

In reality the situation is more complicated: after the deal is signed, the fund pays a premium to the insurer with the fee based on the size of payments. (That fee declines over time.) And the insurer makes payments. At year end everything is netted out.

Longevity risk is one of the two main risks assumed by a pension fund. Investment risk, or the ability to generate the returns required to pay the retirees, is the other risk. To the extent that the fund generates excess returns, those gains can be transferred to the plan members in either reduced contributions or enhanced benefits. On the Canadian Bank Note deal, the fund retains the investment risk. But if a fund wanted to outsource both the investment and longevity risk, it could buy an annuity from an insurer. That plan is not attractive currently because low interest rates make premiums high.

Neil Duffy, a vice-president of pension risk transfer at Canada Life termed the transaction a “milestone” because it was small. “We figured out how to do a small transaction that made sense for the client and us.” Duffy’s group, which, has completed other deals, including one for 6 billion euros in other parts of the world, is now aiming to develop the local market especially for smaller pension funds. “Defined benefit sponsors are looking for ways to manage the risk in their plan,” he said.