‘A favourable valuation environment’: What DB sponsors should do with their surplus

For most of the past two decades, Canadian defined benefit (DB) pension plans were stuck in deficit as plan sponsors watched funded ratios languish below 100 percent, year after year, with little relief.

Now, 90 per cent of plans enjoy healthy surpluses, according to the Mercer Pension Health Pulse. Consequently, the group annuity market in Canada has matured into a credible, competitive de-risking tool.

The question facing sponsors today is whether those two realities can work together. As Mathieu Tessier, vice-president, client relationships and innovation, defined benefit solutions at Sun Life, argues, they actually can.

“You get to have both at the same time," Tessier said. "Now that you are fully funded, you're sitting on some gains, hard fought, hard earned, and you have this mature group annuity business. They're not two mutually exclusive things, or they don't exist in separate universe. They can actually be a very strong duo together.”

What makes the pairing compelling for Tessier is the notion that a group annuity transaction does not drain surplus but rather generate it. Tessier points to the pricing dynamics in the pension risk transfer market, noting that it’s priced in a way that can benefit plan sponsors. When a sponsor swaps a passively held provincial or corporate bond portfolio for a group annuity purchase, the implied yield tends to favour the buyer.

“The implied yield is solid, it's actually a good trade, you end up on the winning side of that," he explained, adding that trade strengthens the plan's funded status.

There is also a more technical dimension. Provincial regulatory environments require actuarial valuations to include provisions for adverse deviation. Depending on the plan's population and asset mix, both buyouts and buy-ins can produce a net gain in surplus simply through the mechanics of the valuation process.

"You've removed some risk with group annuities, it creates a favorable valuation environment where you end up tabulating more surplus," said Tessier.

According to Tessier, the liquidity challenge is widespread as most DB plans have been closed to new entrants or frozen outright, which means their maturity (the ratio of retirees to active members) keeps climbing.

Over time, benefit payments overtake contributions, and the plan turns cash-flow negative. That creates a bind for investment managers, who must set aside a growing portion of the asset mix in liquid, lower-risk instruments to cover monthly pension payments. Private markets and other higher-return strategies become harder to access, narrowing the range of what the portfolio can achieve, explained Tessier.

To that end, he warns against treating surplus as secure, underscoring plans that still carry return-seeking assets like equities remain exposed to market swings, and a surplus sitting in the 20 per cent range today could erode fast. A group annuity purchase addresses that by crystallizing a portion of the surplus, fixing the amount and removing it from the volatility cycle.

He also pushes back on the assumption that locking in surplus through an annuity means forfeiting future growth.

According to Tessier, the annuity replaces the liability-hedging portion of the asset mix, which is typically the more conservative bond holdings and not the return-seeking sleeve.

That growth-oriented allocation remains intact and continues working to build additional surplus. In Tessier's view, group annuities and surplus strategy are not competing options but complementary tools that operate in tandem.

Moving forward, Tessier agues plan sponsors should start by measuring how much risk sits in their asset mix and, ideally, in the entire pension plan, then decide very deliberately which risks are worth taking and in what size. In his view, getting the balance right depends on the specifics of each organisation: its industry, the size and funded status of the plan relative to the sponsor, and its broader corporate, pension, and benefits objectives.

Yet he stressed that the “right” mix should only be set after detailed discussions with consultants and the sponsor. Once a sponsor has defined which risks it wants to run and why, quantitative analysis can assess whether steps such as shifting from return‑seeking assets into liability‑hedging bonds, moving to liability-driven investing (LDI), or executing a group annuity purchase will move it closer to those goals. Consultants are central in putting hard numbers around those choices, he emphasized.

When the aim is to create or enhance surplus, he sees buy‑ins as having a practical edge because they behave more like a plan investment and do not disturb day‑to‑day pension administration, which can speed up governance and decision‑making.

That agility matters when a sponsor wants to act quickly at what it believes is a peak surplus position and is keen not to slide back, particularly as many sponsors, he noted, choose to implement a buy‑in first and leave the door open to convert to a buyout later.

However, he doesn’t see a clear technical winner between buy‑ins and buyouts on surplus impacts driven by actuarial valuation rules and provisions for adverse deviation; the outcome depends heavily on plan‑specific facts. Tessier emphasized that in Canada buy‑ins and buyouts are priced the same, so the real distinctions lie in speed to market, speed of decisions, and how fast a transaction can be executed, rather than in any structural cost advantage.

Tessier ultimately frames the current moment with characteristic bluntness.

"A lot of folks have been waiting for a long time to get back to 100 percent, to even be above 100 percent and maybe to take some risk off this roller coaster," he said. “It's happening now at the same time when you have great de-risking solutions, including a pretty mature and efficient group annuity business. We really feel the pairing is worth a good look. It doesn't solve all the problems... but it's a great time to just take a good look at it.”