Pension plan funding improving in Canada

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Canadian pension plans say their financial status is improving – and a small proportion in the private sector are even reporting funding surpluses.

A new survey of pension plans by advisory firm RBC Dexia Investor Services Ltd. shows a stronger financial position after years of funding concerns, but also indicates pension fund sponsors remain worried about market risks, particularly the threat that inflation could surge and interest rates rise.

The survey, scheduled for release Tuesday, found 85 per cent of pension plans reported they are at least 80-per-cent funded as of April, which means they have assets equal to at least 80 per cent of their estimated liabilities for providing pensions to members.

Six per cent of the 108 plan sponsors surveyed said they have a funding surplus, which means their assets exceeded 100 per cent of liabilities.

A further 22 per cent had funding between 96 and 100 per cent. RBC Dexia said 85 per cent of the funds in this group were at private sector companies rather than public sector or government plans.

The survey included pension plans with assets ranging from $100-million to more than $1-billion.

Scott MacDonald, head of pensions, financial institutions and client service at RBC Dexia, said pension plans' funding has improved due to strong investment performance as well as additional cash contributions from plan sponsors.

"Returns for pension plans have been double-digit territory for some time, and it's been Canadian equities that have led the way," Mr. MacDonald said.

RBC Dexia reported in April that Canadian pension funds earned a 2.3-per-cent return on investments in the first quarter this year and a 12-month return of 10.8 per cent as of March 31.

Mr. MacDonald said pension plan sponsors remain nervous about risks, but those concerns have shifted.

While "third-party" risk – the danger that financial problems at another organization could affect a plan's investments – is still a concern, few rank it as a greater risk than in past years.

Instead, pension plans reported growing concerns with interest rate and volatility risks. RBC Dexia said only 16 per cent of plan sponsors said they were not worried about inflation, while 84 per cent felt inflation risk was a concern.

Inflation can especially affect pension plans that offer benefits indexed to inflation, requiring higher returns to meet those obligations. But pension plans are also concerned that inflation can trigger higher interest rates, which have a broader impact on investments.

While Mr. MacDonald said pension plans can benefit from higher interest rates, they have to be in the right investments to do so.

Plan sponsors reported growing interest in investing in real-return bonds, for instance, which are linked to inflation. And more funds are investing in alternative assets such as infrastructure and real estate, which are seen as a "natural hedge" against inflation.

The survey found 21 per cent of plan sponsors want to boost their holdings of alternative investments, which is the category most favoured for a higher investment allocation. Almost half of the largest pension plans with more than $1-billion in assets anticipate boosting their alternative-investment allocation.

Mr. MacDonald said many smaller pension plans don't have the capacity to invest directly in assets such as infrastructure and real estate, however. Twenty-six per cent of private-sector plans surveyed say they have no money allocated to alternative investment categories.