We believe that pooling risk could benefit savers. We’ve previously outlined five key areas¹ for the next government to address in order to position Collective Defined Contribution (CDC) as a vehicle to unlock these potential benefits. At the same time, we recognise the need to overcome the potential risks associated with CDC. In the interest of learning from the experience of others, we’ll look at different types of Canadian pension plans and instruments that involve longevity pooling, and explore how regulation impacted the formation of those solutions.

Longevity Pooling – many ways to skin a cat

DB Structures

Target Benefit Plans

One Canadian CDC-like arrangement which has traction across some Canadian provinces is the Target Benefit Plan (TBPs). Across British Columbia, TBPs cover around a fifth of members in registered pension plans². They resemble DB multi-employer pension plans, but with the added flexibility to adjust benefits up or down depending on the funding position of the plan.

The legislative frameworks governing TBPs resemble DB regulations. Current consultation is focusing on: 

1. fair treatment of provisions for adverse deviations (PfADs) – a buffer to increase income stability and reduce the likelihood of benefit cuts; and 
2. how to communicate effectively to members. 

It’s no coincidence this echoes what we saw in the Netherlands³, that CDC needs to feel fair and transparent to members for the structure to thrive in perpetuity.

DC Structures

University of British Columbia Faculty Pension Plan

There’s longevity pooling within DC plans too. A long running example is the University of British Columbia Faculty Pension Plan (UBC FPP), a DC plan set up in 1967 to allow faculty members to benefit from higher expected domestic returns than available in the USA (where their pensions were previously invested)⁴.

The mechanism for sharing longevity risk is in the decumulation phase, through the purchase of a ‘Variable Payment Life Annuity’ (VPLA) within the Plan at the point of retirement. Much like a traditional annuity, the proceeds of members who die early in retirement is effectively redistributed to provide income to those who exceed their life expectancy. Unlike a traditional annuity, the VPLA allows a member to retain exposure to risk assets (expected to deliver higher returns, on average) and the level of income is not guaranteed.

Today, VPLAs are unusual in Canada, largely because the federal government effectively banned them from DC plans from the late 1980s - more on that later – although they’re making a comeback.

The return of VPLAs

Off the back of the successful experience of UBC FPP, the federal government reintroduced VPLA options within DC plans in the 2019 budget, and work to include this in provincial level legislation is ongoing⁵. This is allowing the largest DC Plan in Canada ($11.5bn), the Public Employees Pension Plan in Saskatchewan, to design the first new VPLA as a decumulation option within their Plan.

Mutual Funds and Tontine Structures 

Outside of the DC framework, there has also been recent activity to facilitate longevity pooling within other structures. Purpose investments Inc. launched the Longevity Pension Fund in 2021 as a mutual fund, and Guardian Capital launched their GuardPath™ Modern Tontine within a tontine trust. One unique feature is that both are structured around age-based cohorts, rather than pooling longevity risk across different ages.

These arrangements fall outside of pension regulations – instead, they are covered under mutual fund legislation. It’s still early days as to whether these scale, but they afford wealth advisors another lever to help guide clients through personal finance retirement challenges.

What lessons can we take?

Consider indirect impacts of legislation

It’s encouraging to see a variety of mechanisms allowing Canadian pensioners to pool their longevity risk. 

However, the impact of regulatory intervention is evident across the spectrum of different structures:

• Within TBPs, the debate surrounding the role of funding requirements and prudence buffers is causing regulatory uncertainty. This is partly symptomatic of trying to flex concepts originally constructed to safeguard member guarantees in a context where those guarantees don’t apply by design.
• The reason VPLAs were banned from the late 1980s until 2019 is because they were caught up in wider legislation to prevent DC plans from self-annuitizing⁶. For fixed annuities, this was a sensible step to protect members’ interests, given DC plans don’t have additional sponsor support or capital to underwrite guarantees. However, the treatment of VPLAs (grandfathering existing plans and leaving it at that) was the ‘path of least resistance’ to getting the wider legislation enacted, rather than an active decision that VPLAs were bad for members.
• The reason the funds are based on age cohorts is probably because mutual funds must disclose a single unit price. This is a regulatory requirement to mandate transparency and reporting standards in the interest of investors, but it effectively excludes the possibility of pooling longevity risk between cohorts (in an actuarially fair manner⁷) which could be a quicker path to reaching effective scale within the longevity pool. 

It's hard to anticipate these unintended impacts in advance. Therefore, we believe the UK government should:

• avoid being overly prescriptive in their approach to CDC regulations (being principles based rather than rules based);
• ensure regulation enables longevity pooling in the decumulation phase only (like VPLAs), rather than only regulating more complex structures blending both accumulation and decumulation phases (like TPBs)

The Value of institutions and early adoption

The diversity within Canadian risk pooling has been fuelled by the early success of the UBCFPP. In turn, the history and culture of the University supporting faculty members is imprinted on the history and design of the plan. 

In the UK, we also benefit from the existence of similarly long-lived Pension Schemes (Royal Mail and USS come to mind), and if these can act as an institutional heritage that trailblaze the way for improved pension provision more widely, we will collectively be all the better for it.

If you would like to discuss further, please get in touch.
 

¹CDC: Developing a framework for the next government
²Strength in Diversity: What We Can Learn from BC’s Target-benefit Plans
³Going Dutch: are risks better shared?
⁴The University of British Columbia Faculty Pension Plan - History from 1967 - 2017
⁵The Wonders of Variable Payment Life Annuities - Actuarial Solutions Inc
⁶Providing ‘fixed annuity’ type payment streams without the any associated capital to act as a buffer if things went wrong.
⁷The single unit price constrains the mechanism to diversify away the risk that individuals live longer than their life expectancy – distributing proceeds where pool members have died (mortality credits) equality across the pool would imply an actuarial subsidy from ‘old’ to ‘young’ all else equal, given the higher hazard rate for the former.