Markets have rebounded and pension plan assets are going along for the ride, but challenges still remain
The past few years for the pension industry have been difficult, to put it mildly. But for the Top 100 pension plans, things are starting to look up. Pension assets have cracked the $800-billion mark for the first time ever and are closing in on $900 billion. Assets climbed nearly 10%, with a number of plans reporting double-digit increases. And there was just one plan that reported a decline in assets, compared with 26 in 2011.
According to Mercer’s Pension Health Index, Canada’s pension plans were about 82% funded at the end of 2012, up from 76% in 2011. The firm recently revised the methodology for the index, which now includes the impact of deficit funding contributions. Some of those gains were because companies were throwing in money to fund their deficits.
Making additional contributions to pension plans has been a priority for many plan sponsors as they try to improve the funded status. BCE (No. 11 on the Top 100 Pension Plans list) made a $750-million voluntary contribution in 2012 to its plan in order to reduce the future pension obligation.
Also, Canadian National Railways (No. 14) contributed $700 million to its plan last year, on top of $635 million in voluntary contributions since 2010.
The Road to Wellville
“What’s interesting is that 2013, so far, has been an excellent year for plans,” says Manuel Monteiro, a partner with Mercer. He estimates that the index had climbed about nine percentage points to 91% in the first five months of the year as a result of a rebound in global stock markets and an uptick in long-term interest rates. “This year sort of looks like 2009, and we’re seeing a pretty strong recovery at the moment.”
The market rebound has helped a few plans recover somewhat. Air Canada (No. 18) announced in March that its pension deficit dropped by half a billion dollars to $3.7 billion because of a better-than-expected return on its assets. The airline was also granted some relief by the federal government to fund that deficit. Air Canada’s mandatory contributions were reduced to $150 million a year—on top of its current service payments—for the next seven years.
The Office of the Superintendent of Financial Institutions (OSFI) estimates that the solvency ratio of the approximately 400 plans it supervises has also ticked up. It calculates that about 90% of federally regulated DB plans were underfunded on a solvency basis at the end of 2012, compared with 92% at the end of June 2012. And OSFI estimates that the number of plans with a solvency ratio below 0.80 also improved, declining to 61% from 68% in the same six-month period.
Many plans have looked at alternative assets and strategies as a way to boost their returns. “One of the things that’s really well established within our organization is the move into alternative asset classes,” says Bill Hatanaka, president and CEO of OPSEU Pension Trust (No. 15), also known as OPTrust and one of just a few fully funded plans in Canada. “We have been relatively early adopters of moving into the real estate, infrastructure and private equity spaces. And it’s proven to have worked well for us.”
Its infrastructure portfolio returned 23.7% in 2012, while private equity and real estate also produced strong results, returning 20.5% and 17.9%, respectively.
The Nova Scotia Health Employees’ Pension Plan (NSHEPP) (No. 44) has benefited from the use of a liability-driven investment strategy (LDI), which has helped shelter it from a decline in interest rates.
“And that’s been very much related to the happy timing when we put in place the key elements of our LDI strategy,” explains Calvin Jordan, CEO of NSHEPP (formerly known as the NSAHO Pension Plan). “Today, we have less-significant solvency issues than many pension plans, because over the last five years our investment returns kept pace with much of our solvency liability growth.”
Ups and Downs
While a lot of the news has been positive for plans lately, there are still issues they have to tackle. Volatility is still king as equity markets have gone all over the place.
Over the past few years, markets have taken plan sponsors on a roller-coaster ride. The S&P/TSX composite index topped 15,000 back in June 2008 and then proceeded to fall by half over a period of nine months. While the index did get back to 14,000 in 2011, it has dropped about 10% from that level by the end of May of this year. South of the border, the S&P 500 hit a new high in 2007, dropped by more than 50% by March 2009 and bounced back to reach record levels numerous times this year.
Low bond yields are another challenge for DB plans. “The fact that interest rates are so low right now really has an impact on the pension liabilities,” explains Will da Silva, senior partner and national leader, retirement practice with Aon Hewitt Canada. “Until we see some upward movement in the long end of the yield curve, plan sponsors will continue to feel this impact. What compounds the problem at these low rates is the fact that any small downward movement in long interest rates has a relatively large impact on the underlying liabilities.”
Inflation could be another long-term challenge for plans with indexation as a feature. While low interest rates have helped keep inflation down, that could change if the global economy picks up speed. If plans are not well prepared for higher inflation, da Silva says that could potentially lead to a decline in their funded ratio.
The New Normal
Another issue is longevity and that will have an impact on pension plans. “We’re also faced with the fact that our constituents are getting older and that they’re living longer,” Hatanaka acknowledges. “That’s a happy situation from a real-world perspective but challenging from a pension perspective.”
The 2009 Canada Pension Plan Mortality Study notes that the life expectancy of men at age 65 was 15.2 years in 1985. By 2025, that should increase to 20 years. Women will live longer as well. Their life expectancy at age 65 was 19.3 years in 1985 and will increase to 22.2 years by 2025.
Declining memberships are also an issue for plans, such as OPTrust. Its ratio of contributing members to retirees has been going down over time and continues to do so. There are currently 1.2 active members for each retiree, and the plan is trying to focus on figuring out how to expand its membership.
Other plans, such as Resolute Forest Products (No. 45), are trying to keep the plan going after experiencing a restructuring (see “Back from the brink” below). Unlike OPTrust, Resolute has more retirees than active members, outnumbering them by more than three to one.
Despite the NSHEPP’s age (it was established in 1961), the plan is immature compared to other plans and has a relatively small proportion of its liabilities related to inactive members. But Jordan projects that will change dramatically over the next 10 years, with this making its management of contribution risk even more important.
Despite all the challenges plan sponsors face on the horizon, there are still some precautions they can take to help make pension plans more resistant to volatile markets. As equities recover, sponsors should really be thinking about changing their asset mix to reduce risk, Monteiro advises. He adds that as the plan gets closer to being fully funded, the rationale for continuing to take risk is lower and lower.
“I think what many companies should be doing now is look closely at their asset mix and decide whether they need to make changes now to reduce their risk exposure. I think the general sentiment is out there, but there’s not enough decisiveness to make sure that it actually happens,” says Monteiro. “As good as things have been so far, we’ve seen in the past that it can reverse very quickly.”
Craig Sebastiano is associate editor, BenefitsCanada.com. firstname.lastname@example.org
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