Pension Protection Act receives royal assent: Time to take a serious look at annuity purchases

PRT Insights – May 2023

It has already been a strong couple of years in the pension risk transfer market. With higher interest rates driving down the costs to annuitize, record-breaking amounts of risk are being transferred from plan sponsors to insurance companies through the purchase of annuities. If favourable pricing alone is not reason enough for a plan sponsor to consider purchasing annuities, perhaps the new Pension Protection Act, Canada (“PPA”), which received Royal Assent on April 27, 2023, will serve as another strong incentive.

The PPA makes special payments to a pension plan a super-priority while a plan sponsor is restructuring under the Companies’ Creditors Arrangement Act, and makes the special payments and plan deficit a super-priority when the sponsor is placed into bankruptcy. This super-priority puts the pension plan ahead of lenders, including secured creditors. There is a four-year deferral period before the super-priority of pension plan contributions and plan deficit are to take effect. Although we will likely not see the full impact of the PPA for another four years, plan sponsors would be prudent to take steps now to mitigate against potential future risk. While a plan sponsor may not currently be at risk of insolvency, and the pension plan may not currently be underfunded, given today’s high-interest rates and market volatility, coupled with the fact that the PPA places pension deficits in priority over all creditors, plan sponsors may begin to find it more challenging and/or more costly to obtain financing.

Purchasing annuities can be an effective way to transfer pension risk from a plan sponsor to an insurance company, which can serve to reduce the risk of the plan sponsor in the eyes of lenders. Key pension plan risks which are transferred through an annuity purchase include:

• Investment risk – plan investments may have worse returns than expected;
• Interest rate risk – changes in interest rates can cause a plan to become underfunded, resulting in higher contributions being required to be made; and
• Longevity risk – pension plan members may live longer than anticipated.

For pensioners and deferred vested members who were employed in Ontario, British Columbia, Nova Scotia, New Brunswick and Quebec, the plan sponsor is able to fully discharge the pension liabilities after the annuity purchase. This means that any risk associated with those pension liabilities is completely transferred from the plan sponsor to the insurance company. Plan sponsors can significantly reduce the size of their pension plans and the risks associated with those liabilities by purchasing annuities for pensioners and deferred vested members. In addition to the five jurisdictions with annuity discharge provisions already provided for under pension legislation, Alberta and Saskatchewan are also currently considering adding annuity discharge provisions to their legislation.

With interest rates higher than they have been for many years, the cost of purchasing annuities has been favourable, despite the challenges pension funds experienced during 2022. Purchasing annuities can remove these liabilities, not only from a pension plan but also from a company’s balance sheet.

The process of purchasing annuities can take several months to complete as it is important to ensure that the data used is complete and current before going to the industry for annuity quotes. The sooner a plan sponsor starts the process, the sooner these risks are removed from the pension plan and the company balance sheet.

If you have any questions about this or would like to learn more about mitigating your pension plan risk, please reach out to your Eckler consultant.

This article has been prepared for general information purposes only and does not constitute professional advice. Eckler makes no representations or warranties with respect to the accuracy of the information. Nothing in this report should be construed as investment, legal or any other type of professional advice. Eckler is not responsible for the consequences of any use of the information presented in this report and does not accept any liability for errors, inaccuracies or omissions.