As you may have heard or read, Air Canada (AC) is planning to establish AC Life Insurance in 2019 and to annuitize pensions for AC plan members slowly by buying blocks of annuities over 10 to 15 years beginning in the second half of 2019. AC’s explanation of their plan is on the home page for AC Aeronet @ “Enhancement to Management of DB plans;”.
CUPE was briefed in a conference call on the company’s plan by Nathalie Henderson, Senior Director, Pension and Vincent Morin, President, Pension Investments. Shortly thereafter, the union held an internal conference call to discuss the company’s plan. Included on the call were the union’s pension lawyer, the union’s pension actuary, the CUPE National pension expert and CUPE National Staff Rep, your Pension Committee, and the Component President.
One of the concerns about this arrangement is that it appears that Air Canada and AC Life Insurance will not be arms-length entities, so we cannot assume that normal commercial terms will apply through each step of the proposed annuity transaction. But the specific terms of the arrangements have not yet been provided to us.
As a result of the CUPE call, and to get further details of the company’s plan, the union’s pension lawyer sent a letter to Ms. Henderson asking for a copy of the company’s application to the Minister of Finance seeking authorization for AC Life Insurance. The company, which is not obligated to provide the application to the union, denied the union’s request citing the following:
- There are rigorous regulatory requirements AC must meet to establish AC Life Insurance. This includes providing confidential information on AC and AC Life Insurance’s finances in the application that is not, in the company’s opinion, necessary for the union to evaluate the company’s plan;
- There will be publicly available financial information on AC Life Insurance and the other involved insurance companies that will be posted on the Office of the Superintendent of Financial Institutions’ (OSFI) website quarterly. In the company’s opinion, this information will be sufficient to assess the financial health of AC Life Insurance and the other involved insurance companies.
Notwithstanding the company’s reasons for not providing the application, the union believes it is important to review the application, if at all possible, to better assess the company’s plan for AC Life Insurance and protect the interests of the pension plan members. As such, the union is reviewing its options as to how to best respond to the company reply.
The company position is annuity purchases are permitted by the pension plan texts and the Statement of Investment Policy and Objectives (SIPO) as approved by the Management Pension Committee of AC. Another consideration is that OSFI does not require consent for plan sponsors to purchase “buy in” annuities (which is the type of annuity AC plans to purchase). CUPE may object to components of the company’s plan to establish AC Life Insurance to OSFI, however, and if OSFI believes there is merit to the objection(s), an inquiry could be held. As the regulator, OSFI will want to ensure that there is proper governance for AC Life Insurance. AC Life Insurance will also have to adhere to strict rules that apply to Canadian insurers and to the capitalization of AC Life Insurance.
Why is AC doing this? In a nutshell, to shift the risks associated with AC Defined Benefit (DB) pension plans to private insurance companies and to AC Life Insurance and to reduce the possibility of having to make large solvency deficiency payments.
The AC sponsored DB pension plans, similar to other DB pension plans, assume a lot of risk regarding market volatility, interest rates, and longevity (i.e. Life expectancy, which is increasing in Canada). Additionally, as the membership ages, more pension plan members are retiring and collecting pensions. Currently, AC pays out about $725 million dollars in pensions to retirees each year and this is expected to grow to over $900 million in 10 years. Most of this $725 million is provided by investment returns from the pension fund. The pension fund is managed by AC Pension Investments which has been very successful in the last 8 years and has achieved returns averaging over 12% in the last 4 years. At the same time, AC Pension Investments says that it has reduced risk in the DB pension funds considerably from 9.7% in 2010 to 4.5% in 2018 mainly by switching a portion of the investments from equities to alternatives (such as real estate and private debt) and long-term bonds. Since 2009, the DB pension funds have recovered very nicely and currently feature a total surplus, as of Jan 1, 2018, of $2.6 billion with approximately $19.5 billion in the pension funds. But despite this good news, remember that AC’s pension plans have been in dire straits several times since 2000 and experienced very large solvency deficiencies and the risks mentioned above are never going to go away. AC wants to “crystallize” the recent gains by transferring the risks inherit in providing pensions from the pension fund to insurance companies and thereby avoid the risk of servicing future solvency deficiencies.
No one Canadian insurance company has enough capital to offer annuities to all of AC’s retirees which is why the company’s plan includes blocks of annuities being purchased with multiple first insurers. Additionally, the Canadian insurance companies collectively don’t have enough capital to offer annuities to all AC retirees which necessitates the establishment of AC Life Insurance to assume a majority portion of the risk taken on by the first insurers via reinsurance. The information available to the union, as of the date of this bulletin, does not provide the structure and details of the contracts between the first insurers and AC Life Insurance. Therefore, we cannot confirm the mechanics of the deal. One possible structure could involve the first insurer collecting a premium (the purchase price of the annuity) from the pension plans in return for providing the pension payments back to the pension plans which will pass the pension payments on to the plan member/retiree. At the same time, the first insurers will pay a premium to AC Life Insurance to assume a majority of the risk taken on by the first insurers, and AC Life Insurance will make a payment to the first insurers who will pass it on to the pension plans and the plan member/retiree. We will provide further details if and when they are made available.
The type of annuity that will be purchased by the pension plan/pension fund is called a “buy in” annuity. A buy in annuity means the company will continue to administer the pension payment as it is doing now; the plan member/retiree will see no difference in the way their pension is paid and administered. FYI, with a “buy out” annuity, which is the other major type of annuity, the insurance company that the annuity is purchased from takes over payment and administration. With a buy out annuity, the annuity is held in the name of the plan member/retiree and the annuity payment comes directly from the insurance company.
There are some legitimate concerns regarding the company’s plan arising largely from the arms-length concern mentioned above. The main concern is the reinsurance of the first insurers by AC Life Insurance. By undertaking reinsurance, AC is transferring a minority portion of the risk to the first insurers and shifting a majority of the risk to itself via AC Life Insurance. AC appears likely to provide start-up capital for AC Life Insurance. There are also concerns about how much AC Life Insurance will charge in premiums to reinsure the first insurers but, OSFI may want to ensure that the premium levels charged by AC Life Insurance are not increasing risk to the pension plan/pension fund. The level of premium charged by AC Life Insurance may also affect the amount of surplus in the pension plan although the treatment of surplus (such as in windup) under the plan text would not be impacted.
There are also some clear advantages to the company’s plan. Firstly, a portion of the risk of the AC pension plans will be transferred to the first insurers. Secondly, there is additional protection from Assuris, the organization that provides insurance in the event of insurer insolvency. Assuris protection is required of every insurance company licensed to sell products in Canada. If a first insurer as well as AC Life Insurance were both to become insolvent, Assuris would provide 85% of the monthly income for their annuity purchase as a whole. Furthermore, the remaining 15% would be made up, if there were sufficient funds, from the pension fund and lastly AC. This is likely far superior (unless the pension fund is funded in excess of 85%) to lining up as an unsecured creditor, as would be the case now without annuitization, should AC and the pension fund become insolvent. Thirdly, AC can avoid reinsurance margins charged by other insurers by setting up AC Life Insurance. A fourth advantage is the premiums going to AC Life Insurance rather than to another insurance company creates a revenue stream for AC that would not exist otherwise. Lastly, AC Life Insurance could become a revenue generator on its own and contribute to AC profits. The company has advised that AC Pension Investments will manage AC Life Insurance investments. We asked AC what other activities AC Life Insurance might undertake in addition to reinsurance and they replied they did not know yet.
It is important to note, even when some pension plan members are covered by buy-in annuities, if the pension fund was terminated while underfunded, the annuities would be reduced to the same level of pension offered to non-annuitized members (i.e. everyone would get the same percentage of their pension benefit as is the case now with original AC pension plan members in a windup; original CAIL pension plan members in a windup have a different priority system for pension service up to January 1, 2013 and the AC system thereafter).
To conclude, we will mention that annuitizing DB plansis an increasingly popular trend for DB plan sponsors who want to reduce risk and reduce the uncertainty and volatility around their pension contribution requirements. The use of a non-arms-length re-insurer is unusual, however. Your union will continue to monitor the company’s plan as it progresses and will address any concerns with the employer, and if necessary and permissible, the regulator.
Your Component Pension Committee