Improved funding conditions boost Canadian pension plans in 2017

Stabilizing interest rates have eased the pressure on pension funds

Improved funding conditions boost Canadian pension plans in 2017
With interest rates stabilizing, 2017 has started with an window of opportunity for more pension plans to cover funding obligations by buying annuities, as well as invest in new financial instruments to hedge against the risks of plan members living longer.

Referring to a 2017 pension forecast from consulting firm Mercer Canada, the Globe and Mail reports an anticipated leap in annuity contract purchases among Canadian pension plans. From $2.2 billion in 2015 and $3 billion in 2016, annuity purchases are forecast to reach $4 billion to $5 billion this year.

Annuity contracts are a way for managers to lock in costs of providing pensions to plan managers, thus insuring against the risk of future volatility in their investment portfolios. With the interest rate outlook for 2017 being stable to positive, according to Mercer senior partner Jean-Philippe Provost, pension plans are expected to approach fully-funded status. This gives them more freedom to invest in financial instruments to buffer against future funding risks.

Pension plan funding improved dramatically in 2016, with plans reaching an average of 95% funding achieved largely from market gains and interest rate increases following US President Donald Trump’s election.

In spite of such improvements, Provost said some pension plans are still not opting to purchase annuities. Instead, they prefer longevity swaps, financial instruments sold by insurers to cover the risk of plan members outliving actuarial projections. “We’re seeing a lot more interest from plan sponsors in regards to that,” he said.

Canada has seen very few longevity swap agreements, one of which was forged by Canadian Bank Note and Canada Live Assurance in 2016. Under the $35-million deal, Canadian Bank Note is still responsible for its members’ pensions, but would be reimbursed by Canada Life in case pensioners lived longer than expected.

Britain-based Artemis, which tracks deals involving risk transfer and insurance products, has called the Canada Bank Note transaction the smallest longevity swap it is aware of. Provost noted that longevity swaps, historically complex in structure, have become far simpler and therefore available to a broader base of pension plan sponsors.

Mercer also anticipates that in 2017, provinces and even the federal government will launch reviews to explore the adoption of new pension fund rules similar to those that Quebec put in place in January 2016. The new rules no longer require private pension sponsors to fund plans on a solvency basis, which requires funding on the assumption that a plan would be shut down immediately; instead, they assume that plans will continue to operate as a going concern. Provost reported that his firm’s Quebec-based clients have experienced a 40% reduction in their pension contribution requirements as a result of the new rules.

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