A new study by the Canadian Financial Executives Research Foundation found that almost 60 percent of financial executives surveyed indicated that their pension plan posed either a moderate or substantial risk to their organization. The research project was sponsored by Mercer.
At the end of 2012, only about one in 20 Canadian defined benefit plans were fully funded on a solvency basis. The biggest factor in the decline was that long-term interest rates have plunged to their lowest levels in 60 years. Disappointing asset returns, demographic pressures and the increasing maturity of pension plans also have played a part.
“The results indicate that hope for better days is not enough and that Canadian corporations must stop depending on investment returns or increasing interest rates to cover pension funding deficits. Organizations need to plan ahead to lower risk to their plans, through a combination of strategies,” said Michael Conway, chief executive and national president of FEI Canada.
DB plans that want to minimize their risk do have options. The risks could be transferred to another party, such as an insurance company, through an annuity purchase for some or all of the plan members; the benefit policy could be changed to transfer or share risks with employees, such as moving to a DC plan or a target benefit structure; investment policy could be changed to reduce the mismatch between assets and liabilities or to protect against extreme events; or funding policy strategies could be employed to manage the amount and plan the timing of contributions.
Many plan sponsors are looking to modify their plan design as part of their risk reduction strategy. Of survey respondents with DB plans, 58 percent remain open to all employees, 37 percent are closed to new entrants with existing employees continuing to accrue DB benefits, and 6 percent are closed to new entrants, with no further DB accruals for current employees.
Almost one-third of participants said they were either somewhat likely or very likely to close existing DB plans to new employees while continuing benefit accruals for current employees. Sixty-two percent of organizations that have made or are considering changes to their DB plans cited the level and volatility of funding contributions as a very important driver of that change. While plan design changes such as moving to a DC plan can be effective in reducing risk in the long term, they do not have much effect in the short term, according to the report. Sponsors looking to reduce risk in the short term need to turn to investment policy or risk transfers.