Despite the recent market rally, Canadian defined benefit (DB) pension plans’ solvency positions are not much improved from the January 1, 2009 position, according to a recent analysis by Watson Wyatt Worldwide, a leading global consulting firm.
Asset returns have been strong in recent months, more than offsetting the negative asset returns in the first two months of 2009. However, pension liabilities increased almost as much as assets over this six-month period due to a drop in solvency discount rates. The net result is that the solvency position of the typical plan ended up slightly better on June 30 than it was at January 1, 2009. After beginning the year at 73 per cent and plunging to 61 per cent at the end of February, the solvency ratio of the typical plan rose to 75 per cent by the end of June.
Implications for pension plan members
Members of DB plans face a risk of their benefits being cut in the event that their employer goes bankrupt while the plan is underfunded.
“Despite this understandable concern, most members of DB plans should take some comfort in the fact that funding standards still provide for an orderly return to fully funded positions in the medium term,” says Ian Markham, director of pension innovation for Canada. “Further, members of DB plans have so far suffered fewer losses and are less exposed to future risk than members of defined contribution pension plans.”
Implications for plan sponsors
These low funding levels will result in onerous cash requirements for companies that offer DB plans to their employees and/or their pensioners. Governments are providing some temporary relief, for example by extending the timeframe over which employers must pay off deficits, but the financial burden of offering a DB plan is causing concern for many companies.
"There have been many high profile announcements in the United States and the United Kingdom of companies freezing their DB plans or closing them to new hires,” says Markham. “The pace of change from DB to defined contribution among publicly-traded companies in Canada appears to be somewhat slower than the US and UK to date, but Watson Wyatt’s 2009 Pension Risk survey indicates that 30 per cent of publicly traded Canadian companies are considering such changes sometime in the future."
Protective strategies remain important
In order to achieve improved solvency ratios, DB plans will require some combination of additional contributions, market gains and higher interest rates. Plan design changes such as moving to defined contribution for future new hires will generally take many years before having much of an impact on the cost volatility.
“There remains a great deal of uncertainty about how quickly financial markets will recover and by how much,” says Janet Rabovsky, investment practice leader in Watson Wyatt’s Toronto office. “Recent levels of market volatility will remain with us for some time yet, thus making contributions and the movement of interest rates the key determinants of plan health in the short term. Many of our clients are working with us to reduce risk on the investment side, and to take advantage of conditions favourable to de-risking when they arise. ”