The Mercer Canada Pension Buyout Index (“the Index”) tracks the relationship between the estimated cost of settling non-indexed pensioner obligations through purchase of annuities and the accounting liability shown in corporate financial statements for a hypothetical defined benefit plan. Similar indices are also being published by Mercer in the US, UK and Ireland. Mercer also publishes a monthly Mercer Global Pension Buyout Index which compares the cost of insuring DB retiree pension obligations in the US, UK, Ireland and Canada.
This information is intended to help inform decisions with regards to the appropriate time, if any, to consider purchasing annuities. Of course, there are many different ways to manage risk of defined benefit pension plans, ranging from diversifying the growth portfolio, through increases in allocation to liability hedging assets, dynamic de-risking, and settling plan obligations through purchase of annuities. Mercer consultants are available to assist pension plan sponsors, trustees, and administrators with a thorough analysis of the various de-risking opportunities as they apply to their specific plans and helping them decide which approach is the most appropriate for their organization.
The chart below illustrates the estimated cost of annuities for a sample group of retirees expressed as percentage of the corresponding accounting liability that would be disclosed in a plan sponsor’s corporate financial statements. As of June 30, 2015 the estimated cost of annuities for a typical group of pensioners was about 109.4% of the accounting liability. This means that the estimated cost of settling obligations through the purchase of annuities was approximately 9.4% higher than the liabilities shown in corporate financial statements.
The relative cost of purchasing annuities dropped slightly in the month of June, decreasing by approximately 10 basis points from 109.5% to 109.4%. The index has been on a bit of a rollercoaster over the last five years, reaching a high of around 115% in December 2009 and December 2011 and a low of around 103% in Q2 2014.
We note that the accounting liability shown in corporate financial statements does not represent the full long-term economic cost of the pension plan. The full economic cost also includes factors such as provisions for asset defaults and longevity risk, future administration costs, investment management fees, as well as Pension Benefits Guarantee Fund premiums (for pension plans with Ontario members). These additional costs, which will vary depending on the specific circumstances of each plan and market conditions, can be significant and should be taken into account, along with other relevant factors, when considering any de-risking or risk transfer strategy.
In addition to the relative cost measure described above, it is important to consider the absolute cost of settling plan obligations. The chart below illustrates changes in the estimated cost of purchasing annuities and accounting liabilities for a sample group of retirees over time. For the purpose of this chart, the Annuity Cost Index was arbitrarily started at 100% at December 31, 2009. In June, the cost of purchasing annuities fell by nearly 2%, driven by a sharp rise in long-term government bond yields. Similarly, increases in corporate AA bond yields caused a 2% decrease in accounting liabilities.
Whether one looks at the relative or the absolute cost of settling the plan obligations, market conditions can change quickly. As a result, we believe that anyone that wishes to incorporate annuities into their de-risking strategy needs to be prepared and should evaluate in advance the steps required to facilitate such a strategy as well as gauge the financial and investment strategy impact.
After back-to-back record setting years for the Canadian annuity market in 2013 and 2014, first quarter activity was slower than expected, leading insurers to temper their expectations for the rest of 2015. However, Q2 activity has picked up considerably and now general consensus is that total market volume in 2015 could end up rivaling that of the previous two years depending on the closing rate of some of the larger potential annuity purchases in the pipeline.
The chart below illustrates the growth in the Canadian annuity market over the last few years (up to the end of March 2015): Official volume for Q2 2015 will only be released in August.
The Index is provided for a sample group of non-indexed retired members and is only intended to illustrate general trends. The actual premium can vary significantly for individual plans based on a number of factors that may include:
Therefore, the Index should not be used to make any final decisions. If you are interested, we would be happy to help you gain greater insight into expected insurer pricing for your specific plan(s) as well as the implications of settling some or all of your plan obligations through the purchase of annuities.
The Index is based on an estimate of settling non-indexed pension obligations through purchase of annuities and an accounting discount rate based on a proprietary model developed by Mercer to assist our clients with selection of the discount rates used for the purpose of corporate financial reporting.
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This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.