In response to declining funds, some firms are reviewing pension plan design and reducing benefits
Most Canadian pension plans are in “crisis,” creating such financial headaches that chief financial officers are demanding plans be reviewed and in some cases changed, according to a new study.
Of the 68 CFOs surveyed by Watson Wyatt and the Conference Board of Canada, 40 (59 per cent) said there is a pension crisis. Most of those (39 per cent) said the crisis is a result of cyclical factors, with the remaining 20 per cent believing the crisis will last beyond the next few years.
Slumping stock markets since 2000 have left many pension plans in a deficit position without enough assets to cover projected liabilities.
The economic climate at the time of the market collapse of 2000 was uniquely problematic, said Randy Dutka, retirement practice leader, central Canada, for Watson Wyatt. As markets fell, interest rates also dropped. “Assets were going down at the same time liabilities were going up, making things look even worse.”
The study revealed that in response to funding concerns, many organizations are reviewing pension plan design and looking at options like reducing benefits. Poor markets have given sponsors impetus to move from a defined benefit to a defined contribution arrangement.
Of the responding CFOs, 18 per cent said they have terminated at least one of their plans or converted to a defined contribution arrangement due to underfunding. Another 11 per cent said such a change is either underway or planned. Of the remaining 71 per cent that are staying with a DB plan, one in five are either adding defined contribution elements or cutting back on future benefit levels or early retirement provisions.
While many CFOs may be taking the time to review pension plan investment strategies, more than 80 per cent said they will not be making any changes. “If it was well thought out, it won’t need changes on an annual basis,” just because the markets go bad, said Dutka.
Recent improvements in the market suggest the situation is already improving for plan sponsors, but that does not mean CFOs aren’t likely to play a bigger role in pension plan management, said G. Edward Reed, senior researcher with the Conference Board of Canada.
With the collapse of the markets, surpluses quickly turned into deficits and companies had to make larger contributions to support pension funds which in turn reduced cash flow. Once that happened CFOs became much more interested in what was going on, he said. “The pension underfunding issue has moved from the HR department to the CFO and of course to the board of directors,” he said.
But even if the crisis is temporary and likely to resolve itself, it remains that there are other long-term concerns that have caught the interest of CFOs and company directors, he added.
The increased interest is an inevitable by-product of the confluence of several separate though associated developments. Calls for more transparent corporate bookkeeping and better corporate governance, the high profile struggles of several organizations saddled with massive pension shortfalls (Air Canada and Stelco, for example), and an aging workforce are all factors, he said.
In June, new accounting rules will come into effect that will, among other things, require sponsors to provide more pension-related information. (For more on this see the May 31 Guide to Pensions and Benefits).
Even if the markets improve and the current funding crisis subsides, many organizations will be faced with significant increased costs associated with an expectant surge in retiring baby boomers. “As important as HR is in pension plan administration, many of these issues are squarely in the domain of the CFO. He or she is more aware of pension plan underfunding and the consequences for his or her organization.”
They are also more interested because they have been fielding more questions from investors about pension plan health. “Forty-three per cent of CFOs reported that investment analysts have raised the subject of pension plans and post-retirement benefits with them,” said Reed.
Dutka and Reed said one positive development arising from the funding crisis is that both plan sponsors and plan members have a greater appreciation of the risks involved in sponsoring and participating in a pension fund. For years pensions have been kind of neglected, said Reed, and risks were seldom understood.
“Plan sponsors and their advisors are getting better at looking at risk and trying to measure it and understand it,” said Reed. “We are getting a lot better at trying to figure out what risk is, and what risk plan sponsors can take.”
Dutka said that with all the talk about pension funding, now may be an opportune time to make changes to the issue of who bears all the risk. “From a plan sponsor perspective, risk has to be managed somehow. And maybe putting some of it on employees isn’t all that bad.”
But even those sponsors that have tried to pass more of the risk onto members by introducing DC plans will likely face new challenges in the next couple of years, as some members find their plan has not provided them with enough money to retire, said Reed. There have already been a few cases in the United States. “Canadian companies are expected to face litigation in the next two years or so, and the expectation is that the employers will lose,” he said.
CFOs were also asked about what changes to the pension system they would like to see (see chart).
It’s clear poor market performance and underfunding isn’t the only thing bothering CFOs, said Reed. For example, they would like to see an end to the 10-per-cent rule, under the Income Tax Act, which prevents employers from making contributions once assets exceed liabilities by more than 10 per cent. “They know a 10-per-cent surplus isn’t that big,” he said.
The results of the study were released at a two-day conference in Toronto dedicated to exploring strategies for ensuring sustainable pensions.
Peter Cox, CFO of Winnipeg-based agri-business Agricore United, attended to talk about why, following the merger of United Grain Growers and Arigcore, the company made the switch to a defined contribution pension arrangement for its employee groups.
There were two main motivating factors for making the switch, he told Canadian HR Reporter in an interview. The lack of portability of DB plans means any time an employee leaves a plan their pension savings take a hit, he said. This was clear in the agricultural business industry in the ’90s when a significant number of layoffs deprived employees of a substantial part of the DB plan benefits they would otherwise have received, he said.
The DB plan had also become a problem in recruiting, he said. “We were getting employees saying ‘I don’t want to be in your compulsory DB plan,’ or ‘Just give me the employer contribution and let me out.’”
So far the feedback from employees about the transition to DC had been very positive, he said.
“I was a little surprised at some of the observations at the conference that there seems to be a majority view out there that employees view defined benefit plans as in some ways superior financially,” he said.
“The majority of our employees do perceive the DC plan to be an advantage, even after the market meltdown over the last two or three years.” Most of the Agricore United employees are “quite sophisticated” when it comes to retirement planning and investing, he said. But the company has also developed an education and training program to help employees make sound retirement investment decisions. “We do not try to steer them,” he said, but if an employee makes an unusual decision, it is possible to make sure he is well-informed about the possible ramifications of that decision.
“We do recognize that there is more risk that at some future date you may get discontented employees who have made the wrong decisions come back on you and try to make the case that we didn’t educate them or train them,” he said. “Our view is that provided you have a rigorous program of education and training, and built-in checks to make sure employees are not making inappropriate decisions,” the company will be safe from those accusations.
Of the 68 CFOs surveyed by Watson Wyatt and the Conference Board of Canada, 40 (59 per cent) said there is a pension crisis. Most of those (39 per cent) said the crisis is a result of cyclical factors, with the remaining 20 per cent believing the crisis will last beyond the next few years.
Slumping stock markets since 2000 have left many pension plans in a deficit position without enough assets to cover projected liabilities.
The economic climate at the time of the market collapse of 2000 was uniquely problematic, said Randy Dutka, retirement practice leader, central Canada, for Watson Wyatt. As markets fell, interest rates also dropped. “Assets were going down at the same time liabilities were going up, making things look even worse.”
The study revealed that in response to funding concerns, many organizations are reviewing pension plan design and looking at options like reducing benefits. Poor markets have given sponsors impetus to move from a defined benefit to a defined contribution arrangement.
Of the responding CFOs, 18 per cent said they have terminated at least one of their plans or converted to a defined contribution arrangement due to underfunding. Another 11 per cent said such a change is either underway or planned. Of the remaining 71 per cent that are staying with a DB plan, one in five are either adding defined contribution elements or cutting back on future benefit levels or early retirement provisions.
While many CFOs may be taking the time to review pension plan investment strategies, more than 80 per cent said they will not be making any changes. “If it was well thought out, it won’t need changes on an annual basis,” just because the markets go bad, said Dutka.
Recent improvements in the market suggest the situation is already improving for plan sponsors, but that does not mean CFOs aren’t likely to play a bigger role in pension plan management, said G. Edward Reed, senior researcher with the Conference Board of Canada.
With the collapse of the markets, surpluses quickly turned into deficits and companies had to make larger contributions to support pension funds which in turn reduced cash flow. Once that happened CFOs became much more interested in what was going on, he said. “The pension underfunding issue has moved from the HR department to the CFO and of course to the board of directors,” he said.
But even if the crisis is temporary and likely to resolve itself, it remains that there are other long-term concerns that have caught the interest of CFOs and company directors, he added.
The increased interest is an inevitable by-product of the confluence of several separate though associated developments. Calls for more transparent corporate bookkeeping and better corporate governance, the high profile struggles of several organizations saddled with massive pension shortfalls (Air Canada and Stelco, for example), and an aging workforce are all factors, he said.
In June, new accounting rules will come into effect that will, among other things, require sponsors to provide more pension-related information. (For more on this see the May 31 Guide to Pensions and Benefits).
Even if the markets improve and the current funding crisis subsides, many organizations will be faced with significant increased costs associated with an expectant surge in retiring baby boomers. “As important as HR is in pension plan administration, many of these issues are squarely in the domain of the CFO. He or she is more aware of pension plan underfunding and the consequences for his or her organization.”
They are also more interested because they have been fielding more questions from investors about pension plan health. “Forty-three per cent of CFOs reported that investment analysts have raised the subject of pension plans and post-retirement benefits with them,” said Reed.
Dutka and Reed said one positive development arising from the funding crisis is that both plan sponsors and plan members have a greater appreciation of the risks involved in sponsoring and participating in a pension fund. For years pensions have been kind of neglected, said Reed, and risks were seldom understood.
“Plan sponsors and their advisors are getting better at looking at risk and trying to measure it and understand it,” said Reed. “We are getting a lot better at trying to figure out what risk is, and what risk plan sponsors can take.”
Dutka said that with all the talk about pension funding, now may be an opportune time to make changes to the issue of who bears all the risk. “From a plan sponsor perspective, risk has to be managed somehow. And maybe putting some of it on employees isn’t all that bad.”
But even those sponsors that have tried to pass more of the risk onto members by introducing DC plans will likely face new challenges in the next couple of years, as some members find their plan has not provided them with enough money to retire, said Reed. There have already been a few cases in the United States. “Canadian companies are expected to face litigation in the next two years or so, and the expectation is that the employers will lose,” he said.
CFOs were also asked about what changes to the pension system they would like to see (see chart).
It’s clear poor market performance and underfunding isn’t the only thing bothering CFOs, said Reed. For example, they would like to see an end to the 10-per-cent rule, under the Income Tax Act, which prevents employers from making contributions once assets exceed liabilities by more than 10 per cent. “They know a 10-per-cent surplus isn’t that big,” he said.
The results of the study were released at a two-day conference in Toronto dedicated to exploring strategies for ensuring sustainable pensions.
Peter Cox, CFO of Winnipeg-based agri-business Agricore United, attended to talk about why, following the merger of United Grain Growers and Arigcore, the company made the switch to a defined contribution pension arrangement for its employee groups.
There were two main motivating factors for making the switch, he told Canadian HR Reporter in an interview. The lack of portability of DB plans means any time an employee leaves a plan their pension savings take a hit, he said. This was clear in the agricultural business industry in the ’90s when a significant number of layoffs deprived employees of a substantial part of the DB plan benefits they would otherwise have received, he said.
The DB plan had also become a problem in recruiting, he said. “We were getting employees saying ‘I don’t want to be in your compulsory DB plan,’ or ‘Just give me the employer contribution and let me out.’”
So far the feedback from employees about the transition to DC had been very positive, he said.
“I was a little surprised at some of the observations at the conference that there seems to be a majority view out there that employees view defined benefit plans as in some ways superior financially,” he said.
“The majority of our employees do perceive the DC plan to be an advantage, even after the market meltdown over the last two or three years.” Most of the Agricore United employees are “quite sophisticated” when it comes to retirement planning and investing, he said. But the company has also developed an education and training program to help employees make sound retirement investment decisions. “We do not try to steer them,” he said, but if an employee makes an unusual decision, it is possible to make sure he is well-informed about the possible ramifications of that decision.
“We do recognize that there is more risk that at some future date you may get discontented employees who have made the wrong decisions come back on you and try to make the case that we didn’t educate them or train them,” he said. “Our view is that provided you have a rigorous program of education and training, and built-in checks to make sure employees are not making inappropriate decisions,” the company will be safe from those accusations.
