Canada’s financial regulator has “serious concern” about the viability of a rising number of private pension plans, a sign that plans are struggling to meet obligations at a time of low interest rates and weak investment returns.
The Office of the Superintendent of Financial Institutions supervises roughly 1,400 private pension plans covering more than 637,000 employees in federally regulated businesses such as banking, airlines and telecom. When pension plans give rise to “serious concern,” generally because of their financial condition, OSFI places them on a watch list to be actively monitored.
The number of plans on that list continued to rise in the latter half of last year, a spokesperson for OSFI told The Globe and Mail, although at a much slower pace than the steep increase of the prior year. As of early December, there were more than 125 plans on the list, up from 115 at the end of March and 49 at the end of March, 2011. The regulator usually only releases updated numbers in its annual report, but provided the Globe with more recent information in response to questions about an Access to Information request.
In a 2011 report to Finance Minister Jim Flaherty, which was obtained under the Access to Information request, OSFI said that plans with financially weak sponsors and defined-benefit plans with negotiated contributions are particularly vulnerable, noting that the government passed special regulations allowing Air Canada and The Canadian Press more flexibility to pay deficits in their plans. The Globe and Mail is a significant shareholder of The Canadian Press.
Low interest rates and investment returns have caused a decline in a number of pension plans’ estimated solvency ratios, used to measure the ability of a company to meet its long-term debts, which flags them as a concern for OSFI. The regulator tests the solvency ratios of all the plans it supervises twice a year, and has taken actions ranging from restricting the portability of benefits to terminating plans in order to protect plan members.
The main problem that plans face today is low interest rates, says Manuel Monteiro, a partner in Mercer Canada’s financial strategy group. Low rates cut into plans’ projections of what their investments will return, and a rise in rates would go a long way toward bolstering the health of many plans.
Besides low rates, the other key factor is poor stock market returns, with the typical pension plan having 60 per cent of its assets in equities. Plans are now stuck in a bit of a no-win situation. They know their stock exposure is causing too much risk, and they’d like to sell and put that money elsewhere, but to do so would mean locking in losses. And buying bonds now doesn’t make a lot of sense to most investors, with interest rates much more likely to go up than down.
“Companies are now reluctantly keeping the bet that they’ve been taking all along,” Mr. Monteiro said. “Rather than cashing out, they’re saying ‘I hope that interest rates will rise and make the [funding] hole smaller.’ But the flip side of that is that if they don’t, if we end up in a Japan scenario, then things can get even worse than they are now.”
Companies that are holding out hope that rising interest rates will relieve their funding worries are increasingly using letters of credit, rather than cash, to make payments toward the solvency deficits in their pension plans, he added.
“Once you make a contribution to a pension plan, it’s very difficult to get that money back. And so if you really believe interest rates are going to rise, then you see that deficit you have right now as being temporary, so rather than making a contribution in hard cash that you’re never going to see again, maybe it’s better to take out a letter of credit and hope that that deficit disappears, at which point you can collapse the letter of credit.”
Mercer released the latest reading on its pension plan health index on Wednesday, which found a slight improvement in the solvency position of plans in the fourth quarter of 2012. But the vast majority of the improvement stemmed from employer contributions to deficits, as opposed to economic factors. All told, 2012 was not the “bounce back” year that pension plan sponsors had hoped for, it said.
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