Bad year in the markets brings pension woes

The good times had to end eventually for pension plan sponsors and in 2001 they ended in spectacular fashion.

After years of remarkable, often double-digit growth, many pension plans actually reported losses last year due in large part to a terrible year for the stock markets.

For the first time ever, Statistics Canada’s quarterly national estimate of trusteed pension funds reported a “negative cash flow,” as revenues fell almost $5 billion short of expenditures in the third quarter.

The Ontario Teachers’ Pension Plan reported a $1.7 billion investment loss. Combined with benefit payments of $3.1 billion, offset by contributions of just $1.3 billion, net assets were down $3.6 billion last year.

Years of robust fund growth led to surplus assets, lower pension costs and funding holidays. Poor performance not only makes it more costly to run a plan as contributions must increase to underwrite the liability, but losses show up on corporate financial statements at the end of the year, and are often punished by shareholders who don’t like to see red ink.

But pension experts say that for most sponsors there is little need for panic or knee-jerk reactions, though now may be a good time for some plan review to ensure recent strategies still make sense in a very different economic environment.

“We had 10 years of truly wonderful news, now we have had a year and a half of less than wonderful news and the outlook going forward also has questions,” said Gerry Schnurr, a consultant and actuary with Towers Perrin’s retirement practice.

“It’s not even just negative numbers that create bad news,” added Schnurr. Typically, pension funds have to perform at about seven per cent just to break even. Towers Perrin’s review of defined benefit pension plans revealed a 15 per-cent drop for funds in Canada, meaning liabilities are now about 15 per cent larger than fund values.

The need for change will vary from plan to plan and depend on how realistic plan managers have been in recent years, said Joe Nunes, Canadian HR Reporter columnist and pension consultant with Oakville, Ont.-based Actuarial Solutions Inc. For most this will just be a bump in the road. “Well managed plans have been preparing for the possibility of negative returns but some people are probably reeling,” he said.

Some plan sponsors found themselves with a surplus and were unable to resist tapping into it. “It is awfully tempting when the surplus is there to find ways to spend it,” he said. “They have been using up the surplus and running down contribution levels. For them this could be a real crisis.”

In the aftermath of a disappointing year in the stock market, there may be a few more organizations that consider converting to a defined contribution fund, said Nunes. But plan members will likely be a lot less enthusiastic about a defined contribution plan that is losing money.

Sponsors need to revisit expectations, review risks and ensure they are budgeting accordingly, said Schnurr. First of all, plan sponsors must get a good sense of their own financials. “Every senior finance person is asking about the state of pension financials and if you haven’t got a handle on your plan financials, you are going to be in trouble.”

Beyond that, managers must recognize the returns of the past decade are likely gone for the foreseeable future because of the changed economic environment. Decision-makers need to be made aware of the risks and do some portfolio modelling to ensure the right mix is struck between fixed investments (like bonds) and equities to ensure the plan meets growth targets for the year.

For those organizations that do find costs rising over the course of a year, there are accounting practices that can improve the picture. For example, deferring the filing of actuarial valuations for a year or using a smoothing technique in the plan’s solvency test. These do not change the ultimate cost to the plan, but by giving the organization some control of when the new cost incursion is announced the overall impact on corporate financials can be better managed, said Schnurr.

In light of Enron, people may be skeptical about using methods like this, but they are perfectly acceptable practices, he said.

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