# Annuity as DB Pension equivalent



## NorthernRaven (Aug 4, 2010)

Say someone is eligible for a partial federal employee pension from years in a previous job. Starting at age 60, say it pays (hypothetically) $30,000/year, dropping to $25,000 at age 65 (because of coordination with CPP). This looks to be roughly equivalent of having had the pension contributions put into an RRSP, and then buying a 5-year term certain annuity at age 60 (for $30K income), and a life annuity at 65 (for $25K), both CPI-indexed? Could the value of that pension be roughly equated to the cost of buying those two annuities (setting aside any other benefits that might be included)?

The Globe Investor page carries quotes on annuities, but not for inflation-indexed ones. I did find some indexed quotes for a 2% index, which would probably be decent proxy for CPI? From a little Googling, it seems that actual CPI-linked annuities are less common than specific index rate ones?


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## MoneyGal (Apr 24, 2009)

That's one way of valuing a pension; what it would cost to purchase equivalent products on the open market. 

This value will be different from the actuarial present value (a technical fair-value valuation) or the commuted (lump sum) value (offered if you want to exit the pension).


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## rikk (May 28, 2012)

Not sure what you meant by "setting aside any other benefits that might be included" ... the DB will have a survivors benefit @ 50% if that's a consideration ... the annuities, tbd.


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## NorthernRaven (Aug 4, 2010)

"other benefits" were just anything like a prescription drug plan that might be part of the pension package that wouldn't be captured by an annuity comparison. This was just a shooting-the-breeze discussion with some people while watching Season 3 of Boardwalk Empire. Nucky has just given his showgirl friend a "single premium annuity" (a gangster _and_ a financial planner, who knew...). Although (spoiler alert) events conspire so that she won't be able to take advantage of it, someone mentioned they wished they had something like that, and we pointed out they did!

Assuming a 25 year old PersonA and a 40 year old PersonB both take identical salaried jobs with the same federal DB plan at the same time, and quit after 15 years, both getting a deferred annuity pension. I assume the calculated annual pension would be the same for both, and the age difference would come out as a lower commuted value for (the younger) PersonA?

MoneyGal, just out of curiosity, do you have any ballpark sense of what sort of "return" the federal superannuation program might have historically worked out to? If employer/employee contributions had been instead been put in an RRSP, how well would it have to do (probably with more risk) to match the commuted value of the pension being built up? I know it would depend on the years in question, and that superann has tightened up recently, but is there a general sense?

[*Later*]: According to this screed from the C.D. Howe Institute, there is currently an assumed 4.1 real return rate in the federal superannuation plan. I don't know how closely that translates into pension value formulas, but it does make for a nice guaranteed asset class for those of use fortunate to be eligible...


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## NorthernRaven (Aug 4, 2010)

Just for fun, I priced out my hypothetical pension in 2% indexed annuities (male). Assuming that link to indexed annuity rates from January was legit:

$30,000 at age 60, for 5 years: approaching $150,000 ($1720/month per $100,000)
$25,000 for life, at age 65: approaching $450,000 ($470/month per $100,000)

So in some lights, that pension would seem to be approaching $600K in net-worth terms?


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## slacker (Mar 8, 2010)

The math may work out similarly, but they differ in one very important aspect.

The only thing that can cause the government pension to not pay up is when Government of Canada defaults on its obligations. Not to say it couldn't happen, but it's a lot less likely to happen than for let's say Manulife to go under.

I know the recent bull market has erased a lot of the fears of 2008/2009, but remember that multiple financial institutions went under, and many more were close to going under if not for the "shock-and-awe" actions of the Bush government.


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## NorthernRaven (Aug 4, 2010)

slacker said:


> The math may work out similarly, but they differ in one very important aspect.
> 
> The only thing that can cause the government pension to not pay up is when Government of Canada defaults on its obligations. Not to say it couldn't happen, but it's a lot less likely to happen than for let's say Manulife to go under.
> 
> I know the recent bull market has erased a lot of the fears of 2008/2009, but remember that multiple financial institutions went under, and many more were close to going under if not for the "shock-and-awe" actions of the Bush government.


Certainly the government guarantee is valuable, and I doubt anyone would be looking to turn a commuted federal pension into annuities. But annuities by themselves, FWIW, would be covered to large extent by Assuris, the industry's insurance scheme, which would presumably be sufficient for small or medium turmoil. If you are talking about massive shocks that somehow decimate the insurance industry, that's those "to big to fail" problems again, and you'd likely see governments step in if at all possible. 

I'd assume the big Canadian insurance firms are regulated fairly conservatively, and even in the US, was there any significant increase in failures from the crisis?


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## MoneyGal (Apr 24, 2009)

The value of the guarantee is non-financial, but not trivial.


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## Eclectic12 (Oct 20, 2010)

NorthernRaven said:


> ... I'd assume the big Canadian insurance firms are regulated fairly conservatively, and even in the US, was there any significant increase in failures from the crisis?


It's not a big Canadian insurer but the most recent Canadian Insurer to fail seems to be Union of Canada Life Insurance which failed in 2012. 

Before that, the previous and big insurer that failed was Confederation Life in 1994.

http://www.theglobeandmail.com/glob...windup-of-union-of-canada-life/article546284/
http://en.wikipedia.org/wiki/Confederation_Life


In comparison, for the US I can find references to 17 insurance company failures in 2008 (seven of which are life & annuity).

For other years, focusing on L&A failures - these are listed as 11 in 2009 and four in 2010. Lots of P&C or Health failures from 2008 through 2013.

https://www.weissratings.com/ratings/track-record/insurer-failures.aspx


Cheers


*PS*

I'll have to find references for the pre-2008 time period to get a sense for what was happening before. I suspect there were failures where the 2008-2010 was the highest recent number.

I seem to recall references in the google search list that were identifying exposure to sub-prime mortgages as an issue for the US insurers. With the US a different market as well as regulated differently, I suspect that the US insurers were not as conservative as the Canadian ones.


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## Eclectic12 (Oct 20, 2010)

With a big more digging, if one divides the Canadian Life Insurance company failures into "pre-2008" and "post-2008" - the results are three failures are "pre-2008" and one "post-2008".

The three are Les Coopérants in 1992, Sovereign Life in 1993 and Confederation Life in 1994. The post one is Union of Canada Life.

There are the four Canadian Life Insurers that have failed.
http://www.assuris.ca/Client/Assuris/Assuris_LP4W_LND_WebStation.nsf/page/Past+Insolvencies


Note that it is hard to get a good idea of the situation as some insurers sold parts/all of their business as they were weren't making enough money while others sold as they knew that trouble was coming.


Cheers


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