Despite low rates, pension funds on track for new annuity sales record

Despite low rates, pension funds on track for new annuity sales record

Many financial firms have been bearing the yoke of low interest rates for years now, and this has weighed on the fixed-income products they offer. Annuities are one such example, where prices normally increase as interest rates go down. Regardless, Canadian pension funds have been increasing their yearly purchases of annuities according to an article published by the Financial Post.

Citing information from LIMRA and consulting firm Mercer, $2.218 billion worth of annuities were purchased in 2013, more than double the amount purchased in 2012. Purchases in 2014 reached $2.46 billion, and they rose to $2.567 billion in 2015. Data from Mercer shows that annuity purchases reached $1.5 billion during the first nine months of 2016.

According to Brent Simmons, a senior managing director of defined benefit solutions at Sun Life Financial Canada, plan sponsors made around 100 annuity purchases in 2015, while in 2016 the number so far is around 80, making the average annuity purchase size for 2016 larger. Simmons expects total value of business to be at least about the same as last year’s.

Annuity purchases are a solution to the typical problems of defined benefit pension plan sponsors. For a one-time purchase and an associated fee, the fund’s investment risk (a measure of the fund’s ability to generate enough returns to take care of its liabilities) and its longevity risk (the probability that retirees will live longer than expected based on actuarial calculations) are accepted by the insurance company.

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

Aiming to account for pension funds’ increasing annuity purchases despite low interest rates, Manuel Monteiro, a partner at Mercer, explains that most of the rising volume comes from ongoing plans “who are offloading [defined benefit] liabilities as part of their risk management strategy,” as opposed to past scenarios where “most annuities were purchased from plans that were being terminated.”

Another commonality Monteiro sees among new buyer plans is that they are either closed to new members or frozen to new accruals. He estimates the value of assets sitting in Canadian plans that are closed or frozen at $600 billion; the assets invested in the country’s trusteed pension fund business are worth about $1.6 trillion.

Plans can reduce risk further by purchasing even more annuities – a possibility given recent increases in interest rates. “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,” Monteiro said.

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