Five Considerations for Navigating Pension Plan De-Risking

Pension plan administrators are increasingly exploring de-risking strategies to manage various risks associated with defined benefit pension plans. As de-risking becomes more common, administrators need to understand the underlying risks, strategic tools available and the regulatory considerations that shape their implementation.

Below are five key considerations for pension plan administrators when implementing de-risking strategies:

1. Risks facing defined benefit pension plans. Defined benefit pension plans face three core types of risk: longevity risk, investment risk and interest rate risk. Longevity risk relates to plan members living longer than expected, increasing the total pension liability. Investment risk relates to the underperformance of plan investments, while interest rate risk relates to long-term interest rate fluctuations inconsistent with the assumptions used in the plan’s actuarial valuations. These risks drive the need for de-risking strategies that reduce volatility and improve funding certainty.
2. Buy-in annuity contracts. Buy-in annuities are insurance contracts under which the pension plan makes a one-time premium payment to a life insurance company. In return, the insurer reimburses the plan for the monthly lifetime pension payments due to a specified group of retirees covered by the policy. From a regulatory standpoint, the buy-in annuity is considered an investment of the plan, and no statutory discharge is available. This approach is invisible to members and helps mitigate longevity, investment and interest rate risks.
3. Buy-out annuity contracts. Unlike buy-ins, buy-out annuities result in the insurer making direct monthly payments to the covered retirees, thereby transferring the pension obligation from the plan to the insurer. This shift requires member communication and allows the administrator, in certain jurisdictions, to obtain a statutory discharge from future liability provided the prescribed requirements are satisfied. Buy-out annuities also help mitigate longevity, investment and interest rate risks.
4. Longevity risk transfers. Longevity swaps transfer only the longevity risk to a life insurer while allowing the plan to retain control of investments. These contracts are structured as fixed-for-floating swaps, providing plan sponsors with long-term cost certainty (fixed leg) and aligning payments with actual pension benefits (floating leg). While less common in Canada compared to international markets, longevity transfers can play a role in an effective de-risking strategy for certain plans.
5. Annuity purchase process. The de-risking process involves a multi-phase approach that includes data validation, insurer outreach, legal and actuarial review, and contract negotiation. Buy-in and buy-out annuities involve plan administrators working with consultants and legal counsel to issue requests for quotation, assessing template contracts and ensuring regulatory compliance. Bid selection typically occurs under tight timelines, and post-bid execution focuses on finalizing data and contract terms.

Have more than five minutes? Listen to our podcast episode on this topic or contact any Pensions, Benefits & Executive Compensation group member to learn more.