The majority of Canadian CFOs and HR vice-presidents still believe there is a pension funding crisis, but they’re not as pessimistic as they used to be when it comes to the long-term picture.
In 2006, 61 per cent of CFOs and 67 per cent of HR vice-presidents surveyed said they thought the pension crisis would be long-lasting.
This year, those numbers dropped to 48 per cent and 40 per cent respectively, according to the
2007 Survey on Pension Risk
conducted by Watson Wyatt Worldwide in association with the Conference Board of Canada.
The rosier outlook is explained largely by the solid returns on investments in 2006, particularly as interest rates did not drop for the first time in a few years, said David Burke, national retirement practice director at Watson Wyatt in Montreal.
“Liabilities didn’t go up unpredictably and assets went up so there was an improvement in the financial positions of most plans,” he said. But many plans are still in a deficit situation and there is a fair degree of concern.
“The good news is things are getting better, but it also serves to really bring home that if things can improve so much in one year, that tends to show the volatility of the situation,” said Burke. “Things can also get a lot worse in one year. That’s the dampening factor in terms of enthusiasm.”
Survey respondents said the volatility of pension expenses remains a top concern or challenge for defined benefit (DB) pension plans (48 per cent), followed by the current level of pension expense and solvency funding challenges (both 47 per cent) and compliance with changes to pension accounting rules in Canada (45 per cent).
But there is significant activity underway in changing investment policies, as seen with one-quarter of respondents who are considering a move to liability-driven investments to immunize their plans from solvency deficits and stabilize costs.
“They’re not ignoring the fact that what’s most important is not the absolute return of an asset but more how assets performed relative to liabilities,” said Burke.
Conversions to defined contribution (DC) plans continue but it’s dichotomous because organizations make changes to control the risk, such as a DC conversion, but also say DB plans are better from an attraction and retention perspective, he said. And in moving to a DC plan, an employer is not diminishing the risk but transferring it to employees.
“Are they equipped to handle that? I’d say no,” said Burke. “The average person is not financially savvy and not in a position to take the kind of risk that big pension funds can afford to take, and that leads to a higher cost.”
The most serious threat to the sustainability of private sector DB plans is the cost of maintenance and funding (70 per cent), followed by volatility of future funding contributions (63 per cent), imbalance between funding risk or reward (57 per cent) and the volatility of pension accounting expense (51 per cent).
Many plan sponsors are struggling with how to balance risk and reward, said Burke. These plans are long-term vehicles and half the time they’re in significant surplus or deficit but that doesn’t mean contributions should change, he said.
“As much as we’re focused on risk management, and we have to be, these plans were not created to become financial substitutes and to manage risk in an overly conservative way. These plans were created to provide benefits to employees, help them retire and help businesses renew their work processes over the longer-term,” said Burke. “The survey clearly shows that DB plans are superior in this regard.”
This year’s survey covered 141 Canadian organizations, with 45 respondents from publicly traded companies, 44 from private companies, 17 from not-for-profit companies and 41 from public sector companies.
Sarah Dobson is editor of Canadian Compensation & Benefits Reporter, a sister publication to Canadian HR Reporter. For subscription information, visit www.hrreporter.com/ccbr.
The governor’s view: 6 ways to fix DB
Dodge says DB the way to go
Defined contribution plans have their advantages, but appropriately structured defined benefit (DB) plans can do better by pooling risk across all plan members — past, present and future, David Dodge, governor of the Bank of Canada, told those gathered at the 2007 Pension Summit in Toronto last month.
DB plans transfer much of the risk to sponsors, so the liability can dwarf the sponsors’ net worth, he said. For these plans to benefit employees, employers and society as a whole, the party that owns the risk needs to have the proper incentives and flexibility to manage it.
“Putting these plans on a sustainable footing involves strengthening the legal, regulatory, accounting, actuarial and economic frameworks that determine how these plans operate,” he said. He suggested six ways of “getting the incentives right:”
•Sponsors of trusteed DB plans are reluctant to make contributions to cover actuarial deficits because of uncertainty over the legal status of any surplus. While ownership varies, employees generally have rights to pension surpluses but bear none of the responsibility for any deficit. In addition, tax regulations discourage sponsors from building surpluses in excess of 10 per cent. “More clarity regarding the legal ownership of surpluses is needed so that the sponsor that owns the risks also owns the benefits from taking those risks,” said Dodge.
•Regulators typically determine funding adequacy either by assuming a sponsor will make up any shortfall in pension obligations before they come due or assuming a sponsor could become insolvent at any time, so sufficient funds must be available to cover actuarial liabilities. But Dodge said the solvency test places an inappropriate burden on sponsors, as asset values can temporarily fall relative to liabilities, making the solvency deficit significantly larger than the going-concern deficit. “We should accept the fact that some defined benefit plans run by creditworthy sponsors will have substantial solvency deficits from time to time, and make these easier to handle,” he said.
•International accounting standards may replace rules that smooth changes in asset and liability values with rules that focus on values at a point in time. But Dodge questioned the usefulness of this approach. “For plans as a whole, what we are interested in is not today’s values but expected values far into the future,” he said. If the accounting changes happen, sponsor balance sheets and income statements could become more volatile and sponsors overly risk-averse, making pensions more expensive, he added.
•Group longevity risk, thanks to longer life expectancies, also poses a problem for sponsors. This can be mitigated by adjusting contribution rates to reflect changes in average life expectancy or adjusting the levels of benefits or the date at which a person becomes eligible to collect a pension. “We should strengthen incentives to share group-longevity risk between plan sponsors and members,” he said.
•Some labour agreements have called for ¬improvements to DB pensions, without matching funding provisions. But the cost of a new benefit promise should be made “crystal clear” to shareholders, workers and regulators when the change occurs, said Dodge.
•Some sponsors may be too small to adequately manage the risks and costs of a DB plan, but these can be lessened by forming multi-employer plans to pool risks across a number of sponsors, he said.
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