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October 23, 2013
Pension funding slips into “danger zone”

Pension deficits have fallen into “the danger zone” for the first time in more than 10 years, a July 2013 report by the Dominion Bond Rating Service (DBRS) says.

In a review of 461 defined benefit pension plans in Canada, the US, Japan and Europe, the bond rating agency says that aggregate funding levels of the pension funds have slipped to 78.3 per cent, below the 80 per cent level it considers to be the minimum funding threshold.

“An aggregate funded status of below 80 per cent marks the first time that pension funds have fallen into the danger zone in the past decade,” the DBRS reports.  “A mere 41 per cent of funds remained in good shape, down from 45 per cent in 2011.”

The report of dangerously low pension funding comes at a time when markets appear to be steadily recovering from the 2008-09 market crash, which left many pension funds with sizable investment losses.  The continuation of historically low interest rates has also tempered pension fund earnings.

Compounding the problem is a strong increase in pension payment obligations as a growing number of people approach retirement.

“In an extraordinary period characterized by declining interest rates, the increase in plan obligations and benefits paid more than offset the stellar performance from the asset side,” the DBRS reports.  “As long as interest rates remain at current lows, pension deficits will continue to be high.”

Good news may be on the horizon for pension funds as long-term interest rates have risen throughout 2013.  Already some funds have reported improved liquidity compared to 2012 and 2011.   However, according to the Bank of Canada’s September 2013 rate announcement, interest rates will likely remain stable well into 2014.

The bad news for pension fund managers is that the Canadian Institute of Actuaries (CIA) has announced that it is considering changing its mortality tables to reflect longer life expectancies.  For example, a 60-year-old man is now projected to live another 27.3 years, compared to the current estimate of 24.4 years.  A woman the same age is projected to live another 29.4 years compared to today’s calculation of 26.7 years.  

Since the CIA’s mortality tables are used by Canadian pension plans to determine pension payouts and contribution levels, the change could result in an increase in pension accounting liabilities of five to 10 per cent as pension funds may now have to be paid out to retirees or their beneficiaries for longer periods than originally expected.

“We are edging closer to a crisis,” says Jim Leech, chief executive officer of the Ontario Teachers’ Pension Plan, one of the country’s largest pensions.  “Pension plans and sponsors need to come to grips with the volatility in the marketplace and the fact that people are living longer, and therefore have to save more.”

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