Canadian derisking market could favor first movers

Consultants and money managers are warning Canadian corporate defined benefit plans considering derisking that those who hesitate could be lost amid limited availability for long-term bonds and annuities.

“I agree that at a high level there's a concern about capacity,” said Gavin Benjamin, senior consulting actuary, Towers Watson Canada Inc., Toronto. “If it's doable for a pension plan, as more plans move in that direction, it will be more expensive. ... Annuities should also be looked at, but at the same high level, some of the same dynamics exist. Insurers would need similar volume of long-term bonds.”

Added Brent Simmons, senior managing director, defined benefit solutions, at Sun Life Financial, Toronto, “There's a lot of demand and capacity in Canada right now, but we definitely believe there's a first-move advantage for pension funds looking to go into LDI as a first step toward derisking.”

Capacity worries in liability-driven investing center around the availability and liquidity of its investment components, chiefly 30-year Canadian corporate bonds, Canadian real-return fixed income, private fixed income and commercial mortgages. Mr. Simmons said the market for 30-year corporates in Canada “is on the thin side,” and real-return and private fixed income, as well as commercial mortgages, also are in short supply in Canada. With annuities, the concern is that the C$2.5 billion ($1.9 billion) Canadian annuity market won't be enough to cover the derisking needs of corporate plans.

“All of those affect capacity,” Mr. Simmons said. “There are a lot of supply-and-demand factors. Capacity could increase, but right now, it's best that those who want to do LDI get in early.”

Canadian corporate plans' derisking activity has been muted at best. There's been little publicized activity in corporate DB plan derisking apart from large-scale moves — such as the 2013 announcements of an LDI strategy at the C$13.6 billion Air Canada Pension Plan, Montreal, and the pension buy-in of the C$150 million Canadian Wheat Board, Winnipeg, Manitoba, as well as the longevity swap last March involving C$5 billion of the C$19.9 billion in Bell Canada's defined benefit pension plans, Verdun, Quebec.

That doesn't mean corporate plans haven't derisked. But instead of focusing on investment strategy, the risk management moves have targeted changes in plan design, said Jana Steele, partner, pension and benefits, at the law firm Osler, Hoskin & Harcourt LLP, Toronto. For example, as part of Air Canada's pension changes that included a move to LDI, the airline moved many of its new hires into a hybrid DB/defined contribution plan and changed to early retirement provisions for members of unions representing airline employees.

“Plan sponsors in Canada have been looking at several risk management strategies over the last 10 or more years,” Ms. Steele said. “Most of the action with that has centered on changes in plan design, whether it's closing the DB plan to new hires or moving to a shared-risk or target benefit plan. We've seen more plan design changes than other risk management or derisking options. Changing design is another option on the risk management spectrum.”

Canadian annuities and LDI strategies use domestic fixed-income investments because using foreign securities would create mismatches with the liability measurements of plan sponsors that are based on Canadian fixed-income yields and spreads, and also would create exposure to currency risk because the liabilities are paid in Canadian dollars, said Towers Watson's Mr. Benjamin.

On the investment side, Mr. Benjamin of Towers Watson and Sun Life's Mr. Simmons both said the Canadian annuity business is poised for growth. “The Canadian annuity business is growing,” said Mr. Simmons. “There are those who thought it'd never go beyond C$1 billion a year, but in 2014 Canadian annuities totaled C$2.5 billion. The Canadian insurance industry will have the capacity to grow beyond that.”

Added Mr. Benjamin: “There's been a lot of interest in derisking, but it's really the beginning of a trend, and it's early to be able to see how large the market would be. The annuity business has been growing but there's a lot more room for growth.”

Future derisking in Canada should shift to LDI and annuities changes and away from plan design change, said Ms. Steele.

“I absolutely could see (LDI and annuitization) gaining momentum as risk strategies,” she said. “Many of the plans that have wanted to do changes in plan design as a risk management strategy already have made them. Investments and risk transference are the next place that plan sponsors may go to manage risk.”