In 2012, we published “Why annuities are cheap”, an article that changed many people’s perspectives on how valuable group annuities can be to defi ned benefi t (DB) pension plans.

A lot has changed in the last six years – Google now gives us driving instructions and Netfl ix lets us binge watch seasons of our favourite TV shows. And in the pension de-risking world, the Canadian group annuity market has quadrupled in size. We were curious– in today’s economic environment, are annuities still cheap?

We re-did our analysis from the 2012 article and are happy to conclude that the answer is a resounding yes.

Let’s explore this further.

DB SOLUTIONS InSights OCTOBER 2018

Super bonds to the rescueWhy annuities are still cheap

What is a group annuity?

A group annuity policy transfers the longevity and investment risks for a group of members from the plan sponsor to an insurer.

In today’s economic environment, are annuities still cheap?

Yes – annuities not only provide a better yield than a typical bond portfolio, they also provide free risk protection.

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DB SOLUTIONS InSights OCTOBER 2018

Other benefi ts for the planIn addition, purchasing annuities can provide other benefi ts to a DB pension plan, including:

• reducing ongoing actuarial and administration expenses;• reducing Pension Benefi ts Guarantee Fund (PBGF)

assessments; and • shrinking the footprint of the pension plan versus the

company’s balance sheet.

It’s a bird, it’s a plane, it’s an annuity!

What we found in 2012

Six years ago, we expected that the yield on annuities would be lower than the yield on a typical bond portfolio given that annuities provide longevity and investment risk protection. One of the surprising fi ndings was the yield on annuities was actually higher than the yield on a typical bond portfolio. In other words, plan sponsors who purchased annuities were getting risk transfer for free!

Our conclusion then? Annuities were a type of bond that provided a perfect match for DB pension promises. In fact, we dubbed annuities “super bonds” – not only did they provide a good yield, they also provided risk protection.

What we found in 2018

We updated our analysis and the results remain the same. Over the last 3.5 years, annuities have provided an additional average yield of 17 basis points per year over a typical bond portfolio while still providing risk transfer for free.

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Guaranteed pensions for plan membersAnother important goal for many DB plan sponsors is protecting the pensions of their plan members. Annuities provide that benefi t security as insurers are both highly regulated and highly rated. Also, Assuris provides an additional layer of protection to plan members should an insurer fail.

For this reason, Canadian annuities continue to deserve to be called super bonds

Additional yield of annuities vs. passive bond portfolio1

1Assumptions can be found on page 4.

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DB SOLUTIONS InSights OCTOBER 2018

But what about the accounting impact?

Some plan sponsors are concerned that purchasing annuities will impact their earnings per share, but this concern is often misplaced. There are several reasons for that:

Canadian annuities are typically 5% to 10% more expensive than the accounting liability held on the company’s balance sheet1. However, when the accounting liability is adjusted for realistic longevity assumptions, expected credit defaults, future expenses and PBGF premiums, then the cost of purchasing annuities becomes similar to the accounting liability.

Investors recognize this. Many companies that have purchased annuities have seen their share price rise – despite a negative accounting impact. Investors recognize that these accounting impacts are one-time items that improve the quality of the company’s future earnings. This is similar to the way investors regard the one-time charges that companies take when they sell or restructure an underperforming division.

Companies that are still worried about accounting impacts can always purchase a buy-in annuity, which is a type of annuity that doesn’t generate an earnings-per-share impact or require additional cash contributions. Conversion to a buy-out annuity can then happen whenever the conditions are right for the plan sponsor.

What are superhero companies doing?

Increasingly, companies in Canada are looking at annuities as a way to reduce pension risk and ensure benefi t security so they can focus on their core business.

That’s why the annuity market has quadrupled in the last six years. 2017 was the largest market ever at $3.7 billion with a number of innovative transactions including ones involving infl ation-linked promises, active members and jumbo volumes. Interestingly, much of the market was the result of ongoing pension plans purchasing annuities as more plan sponsors took proactive, strategic de-risking action.

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The 2018 market is shaping up to be just as exciting. What are you waiting for? Find a telephone booth and change into super bonds today!

• Talk to your consultant to understand the specifi c characteristics of your plan members

• Get an illustrative annuity quote

• Consider changes to your bond portfolio to prepare for an annuity purchase

1Mercer Global Pension Buyout Index, September 2018.

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DB SOLUTIONS InSights OCTOBER 2018

Group annuities are provided by Sun Life Assurance Company of Canada, a member of the Sun Life Financial group of companies. “FTSE®” is a trade mark of FTSE® International Limited and is used under license. Distribution, republishing and reproduction of any part of this article is prohibited without prior permission. © 2018, Sun Life Financial. All rights reserved.

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For more information about Sun Life Financial’s de-risking solutions, visit sunlife.ca/DBSolutions

Brent Simmons, FSA, FCIA, Senior Managing Director & Head, Defi ned Benefi t Solutions

Brent leads Sun Life Financial’s Defi ned Benefi t Solutions team, which helps some of Canada’s largest employers manage the risks in their defi ned benefi t pension plans with innovative, customized solutions that address the specifi c challenges of each plan sponsor.

Mathieu Tessier, FSA, FCIA, Managing Director, Client Relationships, Defi ned Benefi t Solutions

Mathieu leads a team that works with plan sponsors to understand their DB pension challenges and develop innovative solutions to reduce their pension risk. He is also accountable for providing exceptional service to clients.

About the authors

Plan sponsors are being strategic about buying annuities

They are working with insurers and consultants to get illustrative quotes

One of the best ways to get started is to approach the market for an illustrative annuity quote. This gives plan sponsors more information and allows them to come to market when the timing is right for them.

They are thinking of annuities as an asset class

Many plan sponsors are including annuities in asset mix decisions. Some are even including annuities in their asset liability management studies and considering them as an option when calculating a plan’s optimal asset mix.

They are using custom LDI to prepare for an annuity purchase

More plan sponsors are moving from a passive bond portfolio to custom liability driven investments (LDI), which can help transition to annuities by aligning the portfolio to annuity prices and reducing annuity costs.

They are using bonds to purchase annuities

Plan sponsors are making their fi xed income assets work smarter by using part of their bond portfolio to purchase annuities.

About Defi ned Benefi t Solutions

Defi ned Benefi t Solutions is a team of experienced pension and investment professionals, whose mandate is to help companies manage the risks of their Canadian defi ned benefi t pension plans. We work closely with plan sponsors, consultants and other industry experts to deliver innovative, customized solutions – annuity buy-outs, annuity buy-ins, longevity insurance and liability driven investments – that address the specifi c challenges of each plan sponsor.

About Sun Life Financial

Sun Life Financial is a leading international fi nancial services organization providing a diverse range of protection and wealth products and services to individuals and corporate customers. Sun Life Financial and its partners have operations in a number of markets worldwide, including Canada, the United States, the United Kingdom, Ireland, Hong Kong, the Philippines, Japan, Indonesia, India, China, Australia, Singapore, Vietnam, Malaysia and Bermuda. As of June 30, 2018, the Sun Life Financial group of companies had total assets under management of $986 billion.

Assumptions

Annuity yield: the medium duration annuity proxy rate is the insurer pricing rate for a hypothetical pension plan with a duration between 10 and 11 years. An adjustment of 60 basis points was made to the annuity proxy prior to September 2015 to normalize for the change to the underlying mortality table made at that time.

Passive bond portfolio yield: the duration and convexity-weighted yield is made up of a portfolio of FTSE® Universe and FTSE® Long bonds, where the portfolio duration matches the duration of the medium duration annuity proxy.