Although the markets have shown some positive signs of recovery, the solvency position of Canadian defined benefit (DB) pension plans remains an issue for most plan sponsors. Over the last year and a half, the solvency ratio of a typical DB plan (60% equities, 40% fixed income) showed a significant decline of approximately 35% from December 2007 to February 2009, and then slowly began to rise as of March 2009. The DB plan solvency ratio rose to 80% at the end of July 2009, after beginning the year at 73% and plunging to an historical low of 61% at the end of February 2009, based on a recent Watson Wyatt study.
Asset returns during the last few months have more than offset investment losses reported at the beginning of the year and have led to most of the improvement in the solvency position. Higher yields on Government of Canada bonds during recent months have also helped to slightly improve the solvency ratios of DB plans by lowering pension liabilities. Any improvement in the solvency position of DB plans is good news for plan members, as they face a risk of benefit reduction in the case of a plan sponsor’s bankruptcy if the plan is not fully funded.
Additional scheduled contributions to most DB plans will help to improve the financial situation of these plans in the coming years. These additional contributions—with any luck, combined with increases in interest rates and investment gains—should bring pension plans closer to a fully funded position.
While DB plan members can still be concerned about the underfunding of their pension plans, defined contribution (DC) plan members typically suffer from negative asset returns to a greater extent than DB members—mostly because they are solely responsible for the losses. Many have had to either postpone retirement, due to negative asset returns experienced in 2008, or accept a reduced income in retirement. This has significant implications for near-retirees as they may have to continue working for many more years to recover from the recent investment losses.
Facing huge increases in the plan cash requirements, DB sponsors welcomed the temporary relief offered by most governments. The relief has provided some flexibility to plan sponsors in managing the sudden increased contribution requirements by either allowing for the delay of some of the cash increases by a short period or extending the period required to fund the deficiencies.
Yet despite the temporary relief provided, many DB sponsors are still very concerned about the cost volatility of DB plans. Some are contemplating changing their plans to DC, by either freezing their DB plans or closing them to new hires. According to Watson Wyatt’s 2009 Survey of Pension Risk, 30% of publicly traded Canadian companies are considering such changes at some point in the future.
However, offering a DC plan to new hires or for all future accruals will not affect the volatility of funding requirements with respect to the existing liabilities. At this time, hybrid designs are worthy of consideration.
Without any increases in interest rates and market gains, the typical Canadian pension plan remains significantly underfunded. Plan sponsors that must commit to increased funding requirements may have to reduce internal investments and operational expenditures to fulfill their obligations.
As more sponsors move away from DB plans, the solvency of pension plans will be less of an issue in the future. However, it may also translate into a greater financial burden for individual Canadians.
Martine Sohier is a senior retirement consultant with Watson Wyatt Worldwide.
martine.sohier@watsonwyatt.com
> click here for a PDF version of this article
© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the September 2009 edition of BENEFITS CANADA magazine.