Feds: Boost Surplus to 125%

road narrows signThe volatility of our funded ratio has been an area of significant work and analysis in the wake of the financial crisis – and there have also been recent legislative changes in this area. In this blog post, I will share some of the findings of our analysis and translate them into some feedback and opinion on the legislative changes.

At WCB – Alberta we are in the fortunate situation of a funded ratio that is currently around 130%. That may seem high to many and is high relative to most Canadian defined benefit pension plans. The relatively high ratio is a direct result of financial strategies that are derived from goals and objectives with a key direct influence from the legislative framework around funding levels. By legislation (the Alberta Worker’s Compensation Act) the funded ratio cannot go below 100%. This is exactly the opposite of federal regulated pension plans that by legislation couldn’t go over 110% funded.

The good news is that federal legislation is moving this limit from 110% to 125%. This was part of the Jobs and Economic Growth Act that received royal asset on July 12, 2010 and applies to all contributions made after 2009 for pensionable service after 2009.  125% seems like a very reasonable limit for contributions but could even be a little low. Asset-liability modeling performed with our assets and liabilities supports a target range of 114% to 131%. With this target range the probability of becoming unfunded or dropping below a funded ratio of 100% is small, very small, less than 1% per the asset liability model we use.

There are some important aspects of the modeling and of the workings of our funding policy. The reason the probability of going below 100% is near 0% is partly because of our cushion – we are starting near 130%.  That on its own is not enough. The funded ratio is volatile – very volatile – and we have a relatively low risk appetite, with about 40% equities in our asset mix and liabilities with shorter duration (about 10 years) giving less sensitivity on that side.

Some context for this level of volatility is shown in the following statistics. We track our funded ratio weekly: perhaps we do this more often than necessary, but if you believe ‘what is measured gets managed,’ then it is important to keep front and center the fact that we are managing a balance sheet and not just an asset portfolio.

On a weekly basis the funded ratio has ranged from 101.9% on March 6, 2009 to 135.3% on October 22, 2010. A 33.4% move in less than two years. Now, I admit that March 2009 was an extreme, but even just looking at 2010, the funded ratio started at 130.1% on January 1, 2010, went down to 124.9% on May 21st (remember the European sovereign debt crisis) and then a few short months later it sits at 135.1%. In just six months a move of over 10%.

The funded ratio is very volatile, even with only 40% equities, but the modeling still shows a near 0% probability of becoming unfunded. The main reason is that our funding policy requires large levies if the funded ratio drops below 114%. These levies are added to employer premium rates, they are essentially the same as pension contributions that are above the cost of service in order to pay for an unfunded pension liability. The difference is that we start charging at below 114%. This might seem a bit too conservative but it is necessary to stay over 100%. Staying over 100% ensures that future employers aren’t unfairly paying for the cost of old accidents. An unfunded WCB or an underfunded defined benefit pension plan is a transfer of cost from one participant to another: employer or pension plan member.

To bring it back to legislation, there were also changes made recently in Ontario. Bill 236 Pension Benefits Amendments Act 2010 received royal assent on May 18, 2010 and had its first reading on October 19, 2010. One of the changes is to not allow contribution rate holidays when the funded ratio is below 105%. As these were previously allowed below 105% it’s a step in the right direction. But it’s only a small step. If a funded ratio can move by 30% in two years, and 10% in the last six months, then I would question whether a contribution holiday at 105% makes sense. A plan could start to conduct a valuation, and actually have an unfunded liability before they even finish it — they could then make a decision to have a contribution holiday. A 5% buffer is simply too small given the amount of volatility and funding risk that is being assumed by most pension plans.

In summary, I would give two thumbs up to a federal change that raises the allowed surplus from 110% to 125% and two thumbs down to contribution holidays when at 105% funded ratios.