Companies that offer defined benefit pensions may face rising costs this year and could end up asking regulators for relief, according to a report by human resources consulting firm Aon Hewit on Friday.
The firm’s assessment is just the latest to predict a tough time for defined pension plans in 2012 as a result of lower returns on investments and rock bottom interest rates, which increase liabilities for plans.
Andre Choquet, an investment consultant with Aon Hewitt, said there is already talk in Quebec and Manitoba of the provincial governments providing funding relief for pension plans in those provinces.
He said some companies will be in more difficulty than others because of the pension plan may have “a significant impact on cash flows and balance sheet formation.”
“Even if those plans are closed, they have a legacy liability that has accumulated over the past and they might be in a deficit situation too.”
Choquet said that 96 per cent of the roughly 150 pension plans included in the Aon Hewit review were in a deficit, regardless of industrial sector, and the deficits were bigger than a year earlier.
Aon Hewitt said the median pension solvency funded ratio — the ratio of the market value of a plan’s assets to its liabilities — is approximately 15 per cent lower this year than at the start of 2011
As a result, plan sponsors that file an actuarial valuation this year will need to add more cash to comply with minimum funding rules.
Several of corporate Canada’s biggest names have spent hundreds of millions to shore up their defined benefit pension plans in recent years.
In November, Canadian Pacific Railway Ltd. (TSX:CP) issued US$500 million in debt securities in the United States to help reduce its Canadian defined benefit pension deficit, while Canadian National Railway Co. (TSX:CNR) said in October it would make a $350-million pension contribution for 2011.
Because pension contributions tax deductable, CP said at the time the net impact of the debt offering and the voluntary prepayment was expected to add to its earnings.
BCE (TSX:BCE) made a $750 million voluntary payment on its defined benefit pension plan in December, while Telus (TSX:T) said it would make a $100-million voluntary contribution to its pension fund early in 2012.
BCE estimated the contribution would save about $170 million on its cash taxes, while Telus estimated its contribution would reduce the company’s taxes by about $25 million.
Air Canada (TSX:AC.B) required a special regulation from the federal government allowing it to eliminate its pension deficit over a longer period than usual during its restructuring under court protection from creditors.
Choquet noted that funds with more bonds than stocks did better than those that were more aggressive last year, which saw the S&P/TSX composite index drop more than 10 per cent.
The poor stock market performance contributed to a reduced solvency position for the pensions in Aon Hewit’s study.
Increasing investment in bonds to 60 per cent from 40 per cent would have meant a drop to only a 71 per cent solvency ratio, rather than 68 per cent. The solvency ratio had been about 83 per cent a year ago.
“Defined benefit plans are viable and affordable options for employers, but because of today’s economic uncertainty it requires employers to be clear about the amount of risk they are willing to assume,” he said.
“If you’re taking less risk, there is less chance of being in a worse situation going forward, but you may not be benefitting from an upside much going forward as well … If the stock market increases by a significant amount you may not benefit as much as you would have had, had you taken more risk.”
Choquet recommended a better match between bond and liability duration, noting that pension plans typically invest in universe bonds, with terms of mainly between five and 10 years.
He also suggested that plans look to reduce risk as their funded status improves by gradually increasing their allocation to bonds.
In Canada, only about four in 10 workers have defined benefit plans, which seek to guarantee a set amount of income on retirement. Many companies have switched to defined contribution plans in which the eventual payout is determined by the investment performance.
The Mercer Pension Health Index released earlier this week showed that despite a rebound in stock markets in October, the solvency of most Canadian pension plans failed to improve in the fourth quarter due to a further drop in federal bond yields. The Mercer index has fallen 13 per cent to 60 in the past year, measured against a model reading of 100 for pension solvency.
Meanwhile, pension consulting firm Towers Watson said the deteriorating health of Canadian pensions in 2011 is likely to convince more employers to shift burdens to employees this year and force an increase in retirement ages.