Deepening public-private divide, global diversification among key pension trends

The environment for pension plans in Canada has changed dramatically in recent years, and the challenges facing plan sponsors are multiplying.

The good news is Canadian pension plan sponsors are increasingly taking a proactive approach to the challenges they face. The way they’re responding depends on the type of pension they manage, and the differences between how various plans react — particularly when it comes to divergences between those in the public and private sectors — are becoming stark. Yet on both sides, clear action is taking place.

Read: Plan sponsors using strong solvency positions to tweak investment, funding strategies

The trend is apparent from the results of this year’s Aon pension risk survey, which gathered responses from 124 Canadian pension plans covering nearly 1.5 million members and holding $350 billion in assets. The survey asked plan sponsors a range of questions about their funding, investment and risk management practices. Their answers point to four big trends in how pension plan sponsors are responding to a changing environment:

1. The differences between public and private sector plans run deep.

In the media, the difference between public and private sector plans is often a focal point, but the discussion usually revolves around the perception of more generous benefits for those on the public side. The survey makes it clear the differences between public and private sector plans go far beyond benefit levels.

The key differences reflect the future of the pension plan. For many private sector sponsors, the defined benefit pension plan is no longer a core element of their human resources strategy, with 58 per cent having closed it to new entrants. In the public sector, there’s a much greater commitment to defined benefit plans, with only 11 per cent having closed them to new entrants. The actions taken or planned by plan sponsors reflect that difference.

For example, plan settlement through an annuity purchase is the long-term objective for one in five private sector plans. That compares to only one in 50 public sector plans. A quarter of private sector plans say they’re likely to offer a special lump-sum window for deferred members, compared with eight per cent of their counterparts on the public side.

Read: Plan sponsors eager to take risk off the table

The focus by private sector plans on de-risking is part of a natural progression. By now, many have taken steps to manage costs, whether by reducing benefits or moving to a defined contribution structure. Now, they’re increasingly undertaking the next big step of adopting de-risking strategies and moving towards plan settlement or at least are looking at options that lower the risk of the plan affecting corporate performance.

By contrast, public sector plan sponsors, for whom corporate performance is less relevant, have different challenges. In general, their goal is sustainability, and many are taking actions that ensure the health of their plans for the long run. There are investment elements to that approach, but the issue also arises in funding and liability strategies. According to the survey, more than half of public sector plans have already raised member contribution levels or are likely to do so in the next 12 to 24 months. In the private sector, only about a third of plans are taking that step. Meanwhile, 32 per cent of public sector plans are at least somewhat likely to reduce ancillary benefits in the next 12 to 24 months, compared with just six per cent of those in the private sector.

2. Legislation is driving proactive pension change.

Perhaps it’s not surprising, but the sweeping changes to Quebec’s pension legislation passed in 2014 have led to a corresponding response by that province’s plans. According to the survey, more than 40 per cent of Quebec respondents have changed their funding strategy, and a similar proportion (45 per cent) have altered their approach to investments.

What’s more notable, perhaps, is that plan sponsors in other jurisdictions are already responding to expected legislative reform. In western Canada, where provincial governments have introduced new governance rules but not new funding provisions, a quarter of plan sponsors say they’ve made changes to their funding strategy in response to legislative reform. In Ontario, where the industry is still expecting pension reform, a third of plans have made changes to their funding strategy and one in five have altered their approach to investments.

Read: A look at Quebec’s pension solvency changes one year on

Read: Ontario announces long-awaited DB solvency reforms

Those trends suggest plan sponsors are increasingly taking a proactive stance towards possible legislative reform, rather than simply waiting to see what happens. The approach has a lot of merit. The legislative tide has turned towards reform, particularly for plans in Ontario but also for those across the country, and no plan sponsor can afford to ignore the trend. In that environment, it just makes sense to prepare as much as possible for a potential new paradigm for funding and investment policies.

3. Diversification is breaking through borders.

The days of investing only within Canada are well and truly behind pension plans. According to the survey, more than 90 per cent of private sector plans and 95 per cent of public sector funds take a global view of their investments. That means the vast majority allocate at least part of their portfolios to global assets.

In fact, the trend toward global diversification is broadening. Pension plans’ exposure to non-Canadian equities is significant: 86 per cent of private sector plans and 94 per cent of public sector ones take a global approach to their equity allocations. Yet nearly a third in both sectors also take a global approach to fixed-income allocations. Among public sector plans, which are more likely than their counterparts on the private side to have the resources to find opportunities, global diversification is extending to alternative assets: more than 40 per cent take a global approach to real estate investments, 44 per cent to infrastructure and 37 per cent to private equity.

Read: The challenge of maintaining fixed-income returns as interest rates rise

The survey shows pension plans are seeking ways to reduce exposure to the Canadian market and get the returns they need in a world of low yields. We believe strongly that the trend will continue as globally diversified investment strategies increasingly replace domestic bias.

4. Plans are seeking solutions to investment complexity.

The trend towards a more diversified global approach has a number of benefits but it also comes at a cost: more complexity. Especially for sponsors of small- or mid-size plans that may lack the resources of larger pension funds, the task of implementing an investment strategy can be daunting.

The survey suggests delegation is an option many pension plans are at least considering. Half of respondents said they currently delegate the monitoring of asset managers to outside experts, while 15 per cent say they’re likely to do so.

Read: 2016 Top 40 Money Managers Report: The ins and outs of OCIO

The challenges and opportunities for Canadian pension plan sponsors will continue to evolve, and the survey points to several areas where more change is likely to come. The divergence between public and private sector plans, evolving legislation and global diversification are growing trends that seem poised to define the Canadian pension industry for some time to come.

Tom Ault is a partner for risk settlement and longevity consulting leader at Aon Hewitt. Calum Mackenzie is a partner and investment consultant at Aon Hewitt.

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