Canadian Institute of Actuaries Institut canadien des actuaires

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Annuity Market Speaker: Brent Simmons, Senior

1 Canadian Institute of Actuaries Institut canadien des actuaires Session: Demystifying the Canadian Annuity Market Speaker: Brent Simmons, Senior Managing Director, Defined Benefit Solutions, Sun Life Financial

2 Agenda The Canadian Annuity Market The CIA Annuity Proxy Rate Annuities as an Asset Class 2

3 The Canadian Annuity Market 3

4 How big is the Canadian annuity market? Canadian Group Payout Annuity Market 1,400 1,200 1,182 1,314 Sales (in CAD Millions) 1, , , Sep 30, 2011 YTD (Estimate) Sources: LIMRA & Sun Life Financial Note: Future capacity is anticipated to be greater than past sales 4

5 Biggest single day sales Canadian Group Payout Annuity Market - Single Day Sales Sales (in CAD Millions) May 26, 2009 August 26, 2009 September 19, 2011 Sun Life Financial Other Insurers Source: Sun Life Financial estimates We believe that larger deals will emerge as the market evolves 5

6 How are annuities priced? Complicated pensioner valuation Liability cash flows Longevity is key assumption Asset yield curve Credit spreads are key assumptions Assets must match liabilities Canadas, provincials, corporates, mortgages CPI-linked liabilities must be backed by CPI-linked assets Supply and demand 6

7 Why aren t annuity prices constant? 7.0% CIA Annuity Proxy (UP94G) vs. Canada Long Bond 6.0% Interest Rate 5.0% 4.0% 3.0% 2.0% Canada Long Bond CIA Annuity Proxy (UP94G) Source: Sun Life Financial 7

8 How do I get the best annuity price? Complete data, including type of work Advance notice helps insurers build pipeline 3 to 5 weeks helps insurers secure assets Staggered approach Tranches Bundling of groups Example: retirees and deferreds Talk to insurers regularly 8

9 The CIA Annuity Proxy Rate 9

10 What is the purpose of the proxy? Forward looking: Annuity quotes provided by insurers Expectation of cost of purchasing annuities in the short term Backward looking: Actual deals transacted Point in time cost of purchasing annuities Disconnect in Q and Q

11 What s in and what s out? CIA annuity proxy yield already includes: Insurers provisions for adverse deviations (PfADs) Insurers capital requirements Insurers expenses Insurers views on average longevity CIA annuity proxy yield does not reflect: Duration of pension plan (proxy based on duration around 13) Differences in white collar vs. blue collar longevity (proxy based on average) CIA annuity proxy does not accurately reflect cost of purchasing indexed annuities 11

12 One size doesn t fit all Life Expectancy + 1/2 year Average - 1/2 year Duration 7-15 bps + 25 bps + 65 bps bps + 60 bps + 75 bps bps + 70 bps + 80 bps Source: Sun Life Financial rough estimates (October 2011) Illustrative annuity spreads over CANSIM V

13 Can I buy annuities for indexed pensions? Pension Plans risk management policies typically do not require them to hold CPI-linked assets to back CPI-linked liabilities Masks true cost of making a CPI-linked promise We d like to partner with an interested client to find an innovative solution 13

14 CPI-linked indexing is expensive CIA annuity proxy (100% CPI indexing) Insurer quote (100% CPI indexing) Insurer quote (3% flat indexing) Insurer quote (2% flat indexing) Cost for hypothetical annuity $100 $111 $102 $91 Source: Sun Life Financial rough estimates (October 2011) 14

15 UP94G is usually not sufficient 21.0 Female life expectancy at age UP UP94 AA Improvement UP94 CLIFR Improvement 15

16 Is there a better base rate? 8.0% 7.0% 6.0% Bond Yield 5.0% 4.0% 3.0% 2.0% CIA Annuity Proxy (UP94G) Ontario 20 Year Bond Canada Long Bond (V39062) DEX Long AA/AAA Sources: Bloomberg, PC Bond & Sun Life Financial 16

17 Annuities as an Asset Class 17

18 Highly correlated to bonds 130% Funding Ratio of a Hypothetical Retiree Group 125% 120% 115% 110% Funding Percentage 105% 100% 95% 90% 85% 80% 75% 70% Source: Sun Life Financial 60% Equity / 40% Bonds Long Bonds Universe Bonds 18

19 Bond portfolio vs. annuity portfolio 7.0% 6.0% Interest Rate 5.0% 4.0% 3.0% Net expected return on matching bond portfolio Net expected return on annuity purchase Bond portfolio is 70% DEX long/30% DEX universe, which results in a duration of 10 Source: PC Bond, a business unit of TSX Inc. 19

20 What s the cost of full risk transfer? Hypothetical Pension Plan Gross expected return on matching bond portfolio 4.40% Investment manager and administrative expenses (0.20)% Net expected return on matching bond portfolio 4.20% Insurer Annuity pricing rate (CIA proxy, based on UP94G) 3.60% Adjustment for life expectancy longer than UP94G 0.30% Adjustment for duration difference (13 to 10 years) (0.10)% Net expected return on annuity purchase 3.80% For this hypothetical plan, 40 bps for full risk transfer Rates are at September 30, 2011 Bond portfolio is 70% DEX long/30% DEX universe, which results in a duration of 10 Source: PC Bond, a business unit of TSX Inc. 20

21 At times risk transfer has been free DEX yields were high due to default concerns Difference (bps) DEX Blended Bonds Yield less Adjusted CIA Annuity Proxy Bond portfolio is 70% DEX long/30% DEX universe, which results in a duration of 10 Source: PC Bond, a business unit of TSX Inc. 21

22 Possible consequences Use bonds to purchase annuities? Reflect previous annuity purchases when calculating plan s asset mix? Include annuities as an asset class when doing ALM studies? Monitor bond and annuity markets and be ready to transact? 22

DB SOLUTIONS THANK YOU Brent Simmons 416 408 8935 or brent.

23 DB SOLUTIONS THANK YOU Brent Simmons or LIFE S BRIGHTER under the sun

Session: Session 1 - Pension Plan Financial Reporting (PPFRC) Update Speaker: Deborah McMillan (moderator), Gavin Benjamin, and Manuel Monteiro

Canadian Institute of Actuaries Institut canadien des actuaires Session: Session 1 - Pension Plan Financial Reporting (PPFRC) Update Speaker: Deborah McMillan (moderator), Gavin Benjamin, and Manuel Monteiro