“We’re seeing a lot of plan sponsors regroup in a way that they should hedge against inflation,” Simmons says. “There are different formulas used by sponsors to determine members’ benefits, so the easiest way is to purchase a group annuity that matches those liabilities.”
The simplest change, he says, involves indexing a retired member’s pension at a certain percentage of the current consumer price index. There are also more interesting formulas, where an annuity product can have an offset, floor, and ceiling for their inflation indexing benefits. Depending on their needs, a plan sponsor can be creative in hedging their risks.
Over the years, Simmons says, sponsors have insisted on asking how to buy inflation-linked annuities. In response, the insurance industry thought of different ways to make those products available at a lower cost. He says a proxy measure that tracks the cost of annuities linked to the CPI in Canada has dropped by about 3% over the past year and a half.
“When it comes to the annuity market, pricing usually goes down by a tenth of a percent,” he says. “So a 3% reduction is pretty stuff.”
Some plan sponsors are taking their annuity purchases to the next level by purchasing a basket of annuities, each following a slightly different formula to reduce inflation risk. For those transactions, known as annuity buy-ins, the plan receives payment directly from the insurance company, and the plan sponsor pays the benefits to the members.