Fortunately, the damage to pension funding levels seems to have been minimal, according to Paul Forestell, worldwide partner and leader of the Canadian retirement professional group at Mercer Human Resource Consulting. “Because bond yields have come up, pension plans on the whole are better funded than they were at the end of [last] year.”
“While pension funds may not have direct exposure to the financial instruments that created the problem, they’re going to be affected by it simply because of the contagion effect on the other markets that they are invested in,” says Greg Malone, a principal with Eckler Ltd. The only pension funds that could have some actual exposure to the subprime mortgage market are larger funds, says Towers Perrin’s Steve Bonnar, a principal with the firm. But he says the typical plan has virtually no exposure to any kind of mortgages, let alone a subset of the mortgage market.
However, a global credit crunch that followed the turmoil in the equity markets did affect the Caisse de dépôt et placement du Québec, which held $1.7 billion in a shortterm debt instrument called asset-backed commercial paper(ABCP) at the end of 2006. The lack of liquidity was so bad that the Caisse, along with a number of other financial institutions, helped organize a bailout of the ABCP market.
Still, the market correction wasn’t surprising considering how well stocks have performed over the past few years, says Bonnar. From the beginning of 2003 through June of this year, the compound annual return was more than 20% for the Canadian equity market, he says. “It’s nice when you can get it, but you shouldn’t expect that to continue. At some point you expect some shakeout. Markets are volatile and we’re just seeing that.”
The market volatility isn’t just a problem for defined benefit(DB)plans, but for defined contribution(DC)plans as well. Fixed income investments have also been affected in the wake of the credit crunch, and buyers no longer wanted to be at the front of the line to pick up ABCP. Some funds offered by DC plans do have exposure to this type of debt, and Malone thinks plan sponsors would be well advised to take a look at the money market and fixed income funds they may be offering and decide if any changes need to be made. National Bank and Desjardins Group recently announced they would purchase all the ABCP holdings from their subsidiary mutual funds, while Scotiabank, BMO and TD Bank said their money market funds do not have any exposure to non-bank-sponsored ABCP.
For DC plan sponsors, Malone says communication with members is important at times like this. Members should be reminded about the link between their personal risk tolerance and their investment time horizon and about the effect of dollar cost averaging.
And he recommends DB sponsors should initiate a dialogue with their investment managers and consultants regarding their direct and indirect exposure to the sub-prime crisis. “As always, when reviewing investment strategy, the focus needs to be on the risks. If sponsors have developed strategies to manage or minimize risk, this is an opportune time to see if those strategies are working,” Malone explains. “For those plan sponsors that haven’t evolved their investment and asset allocation strategies amidst a host of investment challenges, the latest events may be impetus to do so.” — Craig Sebastiano
Primer on Subprime What are subprime mortgages? Subprime mortgages are given to people with low credit scores. They can vary from interest-only loans for a five- to 10-year period or an initial low fixed rate loan that converts to a variable rate after two to five years. The U.S. federal funds rate jumped from 1.25% in June 2004 to 5.25% in June 2006. Those holding a subprime mortgage experienced a huge increase in mortgage payments and many just couldn’t pay. Why is this affecting the rest of the market? A lot of the subprime mortgage debt was repackaged and collateralized and sold to various hedge funds and institutional investors. The problem is they were priced for perfection as if nothing was going to go wrong, and the fact is many of these were very risky loans, says Janet Rabovsky, a practice leader, investment consulting, at Watson Wyatt Worldwide. What is asset-backed commercial paper? Asset-backed commercial paper (ABCP)is a short-term debt instrument backed by assets, such as car loans and credit-card receivables. It is usually bought by institutional investors and money market funds. |
Report on Reports
Pension Plans: The Myth of a Pension Problem
By: Dominion Bond Rating Service(DBRS)
Info: DBRS reviewed the 2002 to 2006 results of 536 predominantly North American defined benefit (DB)pension plans.
Key Findings: The public perception of a serious problem in the funding of DB plans in both Canada and the United States is a myth for more than 90% of reviewed plans. Of the plans reviewed, the unfunded liability collectively amounted to only $55 billion(2.83%), based on overall plan assets of $1.8 trillion. More than 25% of plans reviewed are now considered overfunded while 70% are deemed well funded. DBRS believes that the funded status of plans is likely to continue to improve in 2007, leading to an increased number of fully funded plans. With few exceptions, pension funding deficiencies are becoming less of an issue.
2007 Survey on Pension Risk
By: The Conference Board of Canada and Watson Wyatt Worldwide
Info: The survey was completed by 147 respondents from 141 organizations across Canada. The responses were completed by chief financial officers(CFOs), vicepresidents of human resources and individuals in other functional areas.
Key Findings: While two-thirds of respondents still think Canada has a pension funding crisis, the percentage of CFO s who believe the crisis will be prolonged has dropped from 61% in 2006 to 48% in 2007 and from 67% to 40% for VPs of HR. The solid market returns and diminishing pension deficits of the last year have no doubt lowered the level of concern. Funding deficits remain a serious challenge for more than half of respondents. Those with funding deficits in their defined benefit(DB)plans are more likely to implement changes in plan design in the coming year. The most prevalent change is converting to defined contribution(DC)/group registered plans for some (not all)members’ future service. Although DC arrangements hold some attraction, respondents see considerable risks in these plans; they strongly prefer DB plans as the best retirement saving mechanism for attracting and retaining high-performing employees.
For more information on these surveys, go to benefitscanada.com/reports
