Morneau Shepell maintains a database that covers literally all of the defined benefit (DB) pension plans for which the firm performs a funding valuation. The database contains detailed data on hundreds of DB pension plans covering more than a half million active and retired DB members.

The 2015 edition of this database, which was recently completed, yields some interesting insights on the trends around DB pension plans. Consider four trends in particular:

  • Open versus closed DB plans
  • Expected investment returns
  • “Sticky” investment behaviour
  • The demise of inflation protection

The long-term migration to defined contribution (DC) plans continues as 61% of the private sector plans in our database have closed their doors to new hires. We believe this percentage is representative of the entire industry. In a growing number of cases, the DB provision in these plans has been closed to all employees, which makes them prime candidates for a wind-up when they become fully funded.

Read: Role of DC plans underestimated

In some cases, new hires are accruing DC benefits under the same closed DB plan. In other cases, new hires have been placed in totally separate pension plans. Even so, there are now more DC members participating in these closed DB plans than there are active DB members, a fact that is not captured by reports from Statistics Canada.

Will the remaining private sector DB plans also be closed to new hires within the next 10 years? Certainly the public sector would hope that isn’t the case since the DB model would be even harder to defend if no private sector employers see it fit to be preserved.

I see two possible scenarios unfolding in the next decade. Under the first, the percentage of closed DB plans (in the private sector) will peak at 70-80% and then start falling as those plans start to wind up. It is a safe bet that many, if not most, will in fact wind up given that the average age of active members in closed DB plans is now close to 50!

Read: Sounding Board: The gap between DB and DC widens

A small tranche of private sector employers would continue to maintain DB plans for new hires, but the total percentage of all private sector employees who will be covered in DB plans could fall below 5%. At some point, governments may decide that the vast amount of time and effort they currently spend on regulating DB plans is better directed at broader issues.

Under the second scenario, there will come a tipping point when the percentage of remaining open DB plans is so low that shareholders will feel compelled to act and will similarly rush to the exits.

It is also worth noting that there is no plausible scenario in which traditional DB plans resurface. What is still possible, however, is that all plans eventually become either DC or target benefit plans (TBPs). For this to happen, the provinces urgently need to act and adopt TBP regulations that address the thorny problems of (a) transitioning from DB plans and (b) permitting TBPs to be efficiently administered across all jurisdictions. Note that about half the private sector plans in our database are multi-jurisdictional plans.

Read: Why Canada needs just one pension regulator

The second trend is falling expectations for future investment returns. Last year, the best estimate return averaged out to be 6% (if we add back in the margin of conservatism that the actuary specifies in the valuation). This year, it is 5.9%. This is a far cry from the 8% or more that prevailed only a few years ago.

The forecasted return has further to fall if expectations for positive real returns on long bonds start to fade. We have seen past periods when real returns on long bonds have been negative over 25-year periods when yields are low to start.

As for investment policy, it is a little surprising to me as an actuary to see that the median target equity weighting in DB pension plans is just 55%. With yields expected to remain low on fixed income, one might have expected a higher equity allocation. The other investment surprise is the very high percentage of plans in which the assets are still actively managed. Passive management has not really caught on in Canada.

The final observation is the seeming demise of post-retirement inflation protection of DB pensions. The norm within the private sector used to be for ad-hoc increases averaging 50% of the change in inflation to be granted every two to four years. The database shows that this policy now applies to less than 3% of all private sector plans! Most plans describe their pension increase policy as “rare or none,” while some plans continue to provide indexing automatically or conditional upon funding level.

It will be interesting to see whether these trends continue to unfold in the upcoming year.

Fred Vettese is a partner and actuary at Morneau Shepell. These are the views of the author and not necessarily those of Morneau Shepell or Benefits Canada.
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