Why pension annuity sales keep rising

Closed defined benefit plans are reducing risk

In a few weeks we will know for sure. But based on what has occurred so far it seems that 2016 will be the fourth year in a row in which Canadian pension funds have established a new record for the amount of annuities they’ve purchased.

Such purchases represent a one-stop, one-time solution to problems faced by definedbenefit pension plan sponsors. In short, such a purchase — which comes with an associated fee — solves the fund’s investment risk (that the fund will be able generate a high-enough return to meet the associated liabilities) as well as its longevity risk (that the retirees will live longer than they are actuarially supposed to.)

Instead, those risks now fall to the insurance company, which has agreed to take on the responsibilities.

According to information prepared by LIMRA, a “research and development organization that provides companies with retirement, insurance and distribution analysis,” and the consulting firm Mercer, 2013 was the year that saw an big uptick in purchasing annuities: In that year $2.218-billion worth of annuities was purchased — or more than twice what was purchased in 2012.

In 2014, the trend continued with $2.46 billion of purchases, a pattern that repeated itself in 2015 when $2.567 billion of such purchases was made. According to Mercer, $1.5 billion of annuities were purchased over the first nine months of 2016.

Brent Simmons, senior managing director of defined-benefit solutions at Sun Life Financial Canada, said that the 2016 numbers differ from those posted in 2015: Last year, about 100 annuity purchases were made by plan sponsors, whereas in 2016 the corresponding number is about 80.

Accordingly, the average annuity purchase size is larger in 2016 than 2015, noted Simmons, who also expects the total value of business to be at least about the same as last year.

“It’s safer to have converted to a fixed-life annuity,” said Gregory Wyatt, the president of Langley B.C.-based Wyatt Insurance Corporation. “Once that decision has been taken, it’s safer for the pension plan and for the individual members.”

Safety or not, it’s not immediately obvious why in a very low and falling interestrate environment, that pension funds would be keen to pile into purchasing annuities. In other words, why not wait until interest rates rise — a move that all else being equal would reduce the cost of an annuity — and then buy?

Manuel Monteiro, a partner at Mercer, thinks he has the answer. He argues that most of this increased volume has been driven by ongoing plans “who are offloading DB liabilities as part of their risk-management strategy.” And that’s a different group of buyers compared with the past where, he said, “most annuities were purchased from plans that were being terminated.”

And the new buyers tend to share another characteristic: Many of these plans are either closed to new members or frozen to new accruals. By his estimate, about $600 billion of assets are sitting in Canadian plans that are closed or frozen. The country’s trusteed pensionfund business is home to about $1.6 trillion in assets.

In Monteiro’s view, the two main factors holding back these plans from reducing risk is the low level of interest rates and the fact that many of them are not fully funded. “If interest rates continue to increase and the funded position of plans improves, I expect the volume of annuities to increase substantially from current levels,” he said.

THE VOLUME OF ANNUITIES (WILL) INCREASE (IF RATES RISE).