The Price is Right – Or Is It?€¦ · WHY COMPANIES FOCUSED ON RISK MANAGEMENT. $124B. Pension deficits have been . costly. for Canadian companies. Deficit contributions between
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The Price is Right – Or Is It? An Insider’s View of Annuity Pricing and the True Costs of De - Risking Marie Desrochers Sun Life Financial Mathieu Tessier Sun Life Financial SPEAKERS:
Marie Desrochers, Director, Client Relationships, Defined Benefit Solutions, Sun Life Financial
THE PRICE IS RIGHT – OR IS IT?An insider’s view of annuity pricing
and the true costs of de-risking
R O U N D 1
THE PRICE HAS BEEN RIGHT
Presenter
Presentation Notes
Marie: For the last few years, every year has been a new record for the Canadian annuity market…
R E C O R D A N N U I T Y S A L E S I N 2 0 1 8
∼$1B increase2017-2018
17 deals $100M+
$4.6B
Record4th quarter
Q4$1.6B
80% voluntary
Presenter
Presentation Notes
Click – show title of slide only …and 2018 was no different Click – first projector We saw $4.6 billion of sales for annuity buy-in and buy-out combined Click – second projector This represents a $1 billion increase compared to 2017. It’s impressive, but it’s not the first time such an important jump happened. In fact, this is the 3rd time we see a $1 billion jump in the last 6 years Click – third projector In terms of trends, we continue to experience very busy fourth quarters. In fact, Q4 2018 was the busiest of all with $1.6 billion of sales Click – fourth projector Deals are getting larger – we saw 17 deals over $100 million in 2018, compared to 9 in 2017 and 5 in 2016. Last year, that included two deals over $500 million. We feel the $1 Bn + deal may not be too far. Click – fifth projector Focus on risk management: annuity purchases used to be a tool as part of the wind-up process, it’s not only the case anymore. In 2018, over 80% of the sales were voluntary – that means they were in respect of plans ongoing, not in the process of winding-up. TRANSITION: Even if they are not required to do so, plan sponsors are taking de-risking action because many have realized that the DB pension plan business model has failed – and it has cost them a lot of money.
W H Y C O M PA N I E S F O C U S E D O N R I S K M A N A G E M E N T
$124B
Pension deficits have been costly for Canadian companies
Deficit contributions between 1997-2016:
Presenter
Presentation Notes
Click – everything on the slide except the $124 Billion The average DB plan is close to fully funded now but when you think about it… it was close to fully funded 20 years ago Click – $124 Billion appear Over a period of 20 years (between 1996 and 2016), companies in Canada have had to contribute more than $124 billion to shore up the funding levels in their DB pension plans If the traditional DB business model had been successful, plans would be well over 100% funded and these additional contributions wouldn’t have been required. In other words, the pension plan has destroyed value for the company’s shareholders and put the plan participants’ retirement at risk. TRANSITION: Market has accelerated because so many companies liked the deal on the table… pay a one time amount of money, get benefit security for your plan members, and get rid of the pension related risks, so that risk budget can be re deployed in the core business Click – everything except the suitcases
W H Y T H E M A R K E T A C C E L E R AT E D
Navistar
$333M2019
Alcoa
$750M2018
Loblaw
$350M2017
Confidential
$900M2017
Husky Energy
$70M2017
Molson Coors
$ UNDISCLOSED
2016
Large deal in January Another large Canadian deal
Inflation-linked solution
Largest deal & in-kind transfer
First deal with active members
Inflation-linked solution
Presenter
Presentation Notes
A curious feature of the Canadian annuity market is the reluctance of plan sponsors to announce their deals. Even with the steady growth of the annuity market over the past decade, there have been only a few companies that have shared this information publicly, with some examples on this page: Two clicks – suitcases appear and we see the names of the companies This is quite a contrast from the U.K. and the U.S. markets where news releases are common. This trend is starting to change slowly in Canada, because companies realized that not only they got a deal, but the parties affected by the transaction did as well: For plan members, knowing that their pensions are backed by the strict governance policies and financial strength of an insurer is usually welcomed news, especially after some of the recent bankruptcies For shareholders, having a corporation redeploy pension risk to their core businesses where they can gain competitive advantages would be seen as good news as well. TRANSITION: In fact, we don’t talk a lot about the positive impact a transaction like this can have on a company balance sheet
M A R K E T S R E WA R D C O M PA N I E S T H AT D E - R I S K
+1.75%Molson Coors
2017
Risk reduced by 5%
+1.42%CBS Corporation
2017
Risk reduced by 4%
+0.60%International Paper
2017
Risk reduced by 5%
+1.08%Hartford Financial
2017
Risk reduced by 8%
-1.14%United Technologies
2016
Risk reduced by 2%
-1.08%WestRock
2016
Risk reduced by 22%
+0.12%PPG Industries
2016
Risk reduced by 6%
+5.58%J.C. Penney
2015
Risk reduced by 58%
+0.65%Philips
2015
Risk reduced by 6%
+0.06%Kimberly-Clark
2015
Risk reduced by 6%
COMPANIES FIND THAT STOCK PRICES
ARE POSITIVELY IMPACTED BY
ANNUITY PURCHASES
Note: announcement day returns relative to the S&P 500 Index.Source: Divesting to create shareholder value; The Prudential Insurance Company of America; 2018.
Presenter
Presentation Notes
Click – title + call out box appear Prudential recently published a study in the U.S., to look at that impact. In the article, they talk about the fact that these transactions are more than “annuity purchases”, they are a divestiture of a non-core operation No different than any other M&A work done proactively to strategically shrink unprofitable segments, to focus on core businesses Click – all the blue boxes appear The study looked at companies that reduced pension liabilities. And for each case, looked at the stock price outperformance on the date the transaction was announced to the public – we show some examples on the page here. TRANSITION: Really the only way to make the pension plan a profitable business segment, is to get the crystal ball out and make accurate predictions for all the different drivers that have an impact on the funded status – how long will people live, the level of interest rates, equity markets, inflation. Note to Math – some examples on the slide were impacted negatively (2 out of 10). I understand we don’t want to pick and choose and should we only show the most recent ones (2017) to avoid that?
T H E W O R L D I S N O T P R E D I C TA B L E
I N T E R E S T
S L O W SA S E C O N O M Y
R A T E S O N H O L DT H E W O R L D
A B O U T B R E X I TP A N I C K I N G
N E E D S T O S T A R TW H Y U S - C H I N A
T I M E B O M BT I C K I N G
W A R I S AE U R O Z O N E
F E A R SG L O B A L G R O W T HS L O W D O W N F U E L S
I N T H E N E W S
Presenter
Presentation Notes
Click – title only We would have to be right for all these things and if you think of the roller coaster that funded status have been on for the last 20 years – we haven’t been really successful at predicting the future. Click – show the news, 4 clicks total Because it’s hard! They are so many things we have to be right on. And if you think the world has been hard to predict, well it’s not about to get easier if you think of everything in the news these days TRANSITION: Many plan sponsors have thrown away the crystal ball and started looking for a partner who would be willing to take on that business division they no longer want
W H AT FA C T O R S H E L P P L A N S P O N S O R S C H O O S E A N I N S U R E R ?
PRICE
EXECUTION EXPERIENCE
FINANCIAL STRENGTH
CLIENT SERVICE
INNOVATION
Presenter
Presentation Notes
Click – title + wheel of factors Similar to any divestiture, many factors have to be considered when choosing a buyer Click – spin the wheel, start talking as it spins You are picking someone who will be responsible for paying your plan members for the rest of their lives, so you want the transition to be smooth for them and the service to be good. These transactions are becoming larger and more complex and often includes more and more special admin services – it’s important to pick a partner who can deliver on that Also not all plan sponsors are looking for the same solution, so innovation is an important one. For example, do you have a special indexation formula? If so, you want a partner that can figure out the best way to optimize their assets to give you an attractive solution TRANSTION: And like for any business transactions, the price has to be right and one of the objectives of our session today is to give you more information on that very important factor.
R O U N D 2
HOW INSURERS PRICE ANNUITIES
W H AT ’ S I N A N A N N U I T Y P R I C E ?
What are the four key factors that drive annuity prices?
A: Longevity B: Asset yields
C: Supply and demand D: Governance/data readiness
BOB ROB
W H Y L O N G E V I T Y M AT T E R S
ROBBOBMarital status Married Widower
Region Richmond Hill, Ontario North Battleford, Saskatchewan
Socioeconomic status High Low
Job type Management in financial company Manual labourDisability Healthy DisabledPension amount $50,000 $15,000
Bob vs. Rob: greater than 30% difference in premium
Blue collar vs. white collar: experience shows 4%-6% difference in premium
Life expectancy at age 65
30years
20years
A S S E T S M A K E T H E D I F F E R E N C E
50%50%
10%
40%
50%
Traditional Annuity asset mix
Equities Fixed incomePrivate fixed income
Government bonds
Corporate bonds
A C L O S E R L O O K AT I N S U R A N C E P R O F I T S
$100M liabilities
Expected pension payments
Expenses
Profit
5% required equity capital = $5M
12% return on capital = $0.6M
Annual profit of $0.6M Thin margins
INSURANCE
Profit margin of ~80%
Source: MarketWatch
Profit margin of 60%-70%
Source: phoneArena.com
Annuity deal
Presenter
Presentation Notes
https://www.marketwatch.com/story/what-starbucks-7-coffee-is-really-worth-2012-11-29 While the Costa Rica Finca Palmilera beans which went on sale at select locations recently are expensive — they come from a relatively rare cherry of the Gesha tree — the 16-ounce cup should cost just one dollar more than a regular cup of coffee, including the company’s overhead, says James Freeman, owner and CEO of Blue Bottle Coffee. (The price of Starbucks’ regular Grande coffee is $2.20 in New York.) Freeman should know: his chain also charges $7 for a similar cup of Gesha coffee. In fact, an 80% markup is standard in the coffee business on the higher-end brews, he says. https://www.phonearena.com/news/Profit-margins-on-the-iPhone-have-fallen-to-60_id111023 Apple's profit margin on the iPhone has fallen from a peak of 74% to 60% over the years
Comparing annuities to a passive fixed income portfolio
Presenter
Presentation Notes
Annuities are strong/cheap – especially compared to other options for that investment. The expected yield on an annuity has been higher than a comparable duration-matched passive bond portfolio. Annuities include investment and longevity risk transfer for free – in addition to decreasing the time and attention needed to administer the plan – benefits that a bond portfolio can't provide. Better yield + risk protection gives you a super bond. Trade away the unhealthy (volatile) habits completely - annuities
0.00%
0.10%
0.20%
0.30%
0.40%
-0.10%
A N N U I T I E S A R E S T I L L C H E A P
Risk premium, expenses and profit
Passive universe bonds
Yield
Comfort with credit + illiquidity
0.17%
Presenter
Presentation Notes
Annuities are strong/cheap – especially compared to other options for that investment. The expected yield on an annuity has been higher than a comparable duration-matched passive bond portfolio. Annuities include investment and longevity risk transfer for free – in addition to decreasing the time and attention needed to administer the plan – benefits that a bond portfolio can't provide. Better yield + risk protection gives you a super bond. Trade away the unhealthy (volatile) habits completely - annuities
Significant market risks reduction
Can self-insure against longevity
Able to fund plan over time
S H O U L D YO U D O I T YO U R S E L F ?
✓
✓
✓
True elimination of market risks
Transfer longevity risk
Benefit security for plan members
✘
✘
✘
✓ ✘
Presenter
Presentation Notes
Flexibility to seek extra return via equity risk premium Ability to generate surplus to fund an existing deficit Ability to generate surplus to pay for future DB/DC accruals Ability to benefit from a potential future increase in interest rates Ability to fund towards industry standard mortality table (generally less conservative) Flexibility to stagger full funding of the plan Ability to use assets as collateral for an equity/fixed income overlay
R O U N D 3
THE “FINAL ANSWER” FOR SPONSORS
Presenter
Presentation Notes
Still need to find a transition, depend on final title of the slide and how Math ends his section Key messages/speaking notes not final, will depend on final slides
H O W YO U C A N G E T T H E B E S T A N N U I T Y P R I C E
Be proactive Align your investment portfolio Be ready to act Gather detailed data
Presenter
Presentation Notes
Be proactive – Forward-thinking plan sponsors are investigating solutions, educating stakeholders and engaging with consultants and insurers so they can use annuity purchase as an effective risk management tool. Align your investment portfolio – Investing plan assets to move like liabilities can reduce risk immediately and facilitate a future annuity purchase by in-kind asset transfer. This can reduce trading costs and result in a better annuity price. Be ready to act – Annuity pricing can change quickly as insurers’ assets and appetites change. A plan sponsor that is ready to transact can take advantage of great pricing opportunities that can come and go quickly. Gather detailed data – Math covered the factors and longevity is a huge one. Information on job types and mortality experience can help insurers evaluate the group’s mortality. This can result in a better price by allowing insurers to reduce their margins for uncertainty.
C A S E S T U D Y: P R O A C T I V E & D ATA D R I V E N S P O N S O R
$164 million annuity buy-out deal
in 2018
• Mining company in northern Canada• Total DB assets of ~$430 million• Purchased annuities for over 1,000 inactives
Rebounding solvency ratios
T H E P R I C E M AY N O T A LWAY S B E R I G H T
Deals are getting larger
Presenter
Presentation Notes
Many plan sponsors believe that the price has been right When it comes to the market in 2019, there is no indication that things are slowing down: Solvency ratios have already rebounded from Q4 We’ve seen a busy Q1 Talking to plan sponsors from all geographies and all industries We are talking to all major consulting firms With all our pipeline discussions, we estimate the market could be as high as $xx billion this year Now that $xx billion represents all the potential deals from plan sponsors and consultants who told us, 2019 could be the year. As you know, this is a voluntary market now – so will it all happen this year? It’s unclear There is a lot of unclear / uncertain things with this market but one thing that is sure, is that supply and demand is one of the key factors driving the pricing The supply may not be infinite and the price may not always be right Note to Math – are we doing it?
