Canadian companies saw their pension funds swell last year as equity investments provided handsome returns.

The investment was so good that consultant Mercer estimated that 40 per cent of funds were fully funded at the end of last year, putting them in the best position they’ve been in 12 years.

But that means they face some decisions about how to reduce the risk on those funds, says Ian Markham, Canadian retirement risk management leader at Towers Watson.

One alternative is to cash out some of the gains from equity investments and put the money in an annuity that can be managed by a third party insurer, known as a buyout, he said in an interview with CBC’s The Lang & O’Leary Exchange.

“They give their money to the insurance company, the insurance company invests it themselves and pays the money to the party who’s supposed to get the payment,” he said. 

This form of pension structuring is common in the U.S. and U.K., Markham said.

Biggest 'buyout' so far

A Canadian company has recently bought $500 million of annuities from an insurer, with the insurer to take over guaranteed payouts that match its pension obligations, Markham said.

Towers Watson would not reveal the name of the company, but said this was the largest such deal in Canada and the start of a trend toward such arrangements.

“Only a few years ago, the entire annual market for group annuities was half a billion, which is the size of this. Just in the past few years it’s gone up to $2 billion and it seems to be on the increase so there’s a new interest in annuity type arrangements,” Markham said.

The benefit of buying a group annuity is that the company moves its pension fund risk off its own books.

Danger in equities 

“The danger is investing more in equities, because the markets are very volatile. If the company were to go bankrupt, then the danger is the pensioners might not get their money,” he said.

He said the solution won’t work for every pension fund, but it’s particularly attractive for mature companies with large funds who need to plan for many retirements going forward.

The “downside” of such as deal is that the pension fund can miss out on market opportunities as equities rise, the good side is that they don’t have to time the market to avoid a sharp downturn, Markham said.

“It’s a decision on what’s good for the plan members. It’s a decision on what’s good for the company. How should it spend its capital, where should its capital go, what risks should it take for the future?” Markham said.