Corporate pension plans that came into the coronavirus crisis in weak shape are markedly less healthy now, and are facing hundreds of millions of dollars in new contributions to fix looming shortfalls.
Canadian plans on average were well-funded at the end of 2019, with a dollar of assets for every dollar of future benefits it needed to pay. But even those healthy plans have been dented over the past six weeks, due primarily to the sharp fall in equity markets. Falling interest rates – which force plans to increase the size of their liability for providing future pension benefits – are also to blame.
The plans that were in the worst shape had hundreds of million in unfunded shortfalls at the end of 2019 based on a regulatory solvency basis, and have almost certainly seen those shortfalls balloon since.
The expanding deficits raise the spectre of the companies needing to inject millions more into their plans just as their businesses contract with the global recession.
Based on pension data compiled by S&P Global Market Intelligence from 150 Canadian companies’ most recent annual reports, corporate pension plans on average were 98.7-per-cent funded at the end of 2019. But there were that 67 were less than 85-per-cent funded, as measured by the ratio of assets to liabilities.
One-third of the 150 companies had shortfalls of $100-million or more – and while that number may not be overwhelming for a large, profitable company with an adequately funded plan, it suggests many would have to write big cheques to get their plans to 100-per-cent funding.
The numbers reported in the companies’ financial statements are not a perfect guidepost to what’s next, however. When reporting pension liabilities to shareholders, companies are allowed to use interest rates based on corporate debt – and those rates have risen in the current crisis, often offsetting the stock-market damage.
Regulators in Canada and many other jurisdictions instead look at pension health based on government interest rates, which have decreased in 2020, making the liabilities look bigger. The result is that companies may end up worse off on a solvency funding basis – possibly requiring future cash contributions to the plans to meet regulatory funding rules – while reporting lower pension liabilities for financial statement purposes.
Consultants Mercer Canada Ltd. and Aon PLC say their measures of pension health suggest the typical Canadian plan’s funding ratios dropped sharply since the end of 2019, by 10 to 20 percentage points. Mercer said its pension health index closed 2019 at 112 per cent but fell to 93 per cent, the lowest level since 2013, on March 31. Aon said its average measure of pension solvency in Canada declined from 102.5 per cent on Jan. 2 to 89.1 per cent on March 31.
“Given the massive drop in bond yields on government bonds, pension deficits should rise significantly, precisely at the wrong time when companies may have to face a potential economic downturn,” says Dimitry Khmelnitsky, an analyst at Veritas Investment Research Corp. who has authored the company’s reports on pension health at TSX-listed companies.
Bombardier has long been known for its pension challenges – it closed 2019 with a pension deficit of more than $2.5-billion in Canadian dollars, the biggest among Canadian companies by more than $800-million. Its funding ratio was just under 79 per cent, according to the S&P data.
The company has been trying to fix its balance sheet with the announced sale of its Bombardier Transportation business to Alstom; about $1.3-billion of the unfunded liability will go to Alstom in the transaction, spokeswoman Jessica McDonald said.
According to Bombardier’s financial statements, a quarter-point increase in interest rates would cut about $670-million from its year-end liability. But the opposite is also true: A quarter-point decrease in interest rates adds about $670-million to the liability.
About one-third of Bombardier’s roughly $9.5-billion in pension assets were invested in the stock market at the end of 2019, the company’s annual report says.
Ms. McDonald said the company’s pension funding level is “not abnormal” among large Canadian companies. “Despite the extraordinary situation the world is currently facing, we have managed and will continue to manage our risks in a very tight, prudent and pro-active way,” it is “unfair to characterize Bombardier’s plan as below-average in funded status or with a liability too large” compared with the company’s profitability.
Resolute Forest Products Inc., the company formed from the merger of Abitibi and Bowater, reported an unfunded liability of $1.7-billion at the end of 2019, with a funding ratio just under 75 per cent. The unfunded liability was more than six times the company’s EBITDA, or earnings before interest, taxes, depreciation and amortization, of about $275-million in the past 12 months, the S&P data say.
The company doesn’t break out its Canadian defined-benefit plans separately, but about 5,300 of Resolute’s 7,100 employees are in Canada.
Spokesman Seth Kursman said that while $1.7-billion is the number required by accounting rules, regulatory requirements differ across the countries where the company operates, and in many places, the company does not need to achieve a 100-per-cent funding level. Resolute estimates the deficit it was required to fund as of the end of 2019 was about $650-million.
The company has put $1-billion into its Canadian registered retirement plans since 2009, he said, and has maintained plan assets at about $5-billion despite more than $400-million a year in benefit payments, he said. “We’re going to manage this, and we’re going to come through it.”
West Fraser Timber Co. Ltd.'s $273-million unfunded liability results in a funding ratio just under 85 per cent, but it’s more than twice the company’s recent EBITDA.
“It was a particularly challenging year for the forest sector,” chief financial officer Chris Virostek said in an e-mail. “As a commodity industry that is prone to peaks and troughs, a single year is rarely representative of typical earnings.” Using a two-year average of EBITDA, he says, suggests it takes just over four months of profits to cover the deficit.
Cash contributions and investment returns caused plan assets to grow by 15 per cent last year, he said.
Editor’s note: (April 7, 2020) This story has been updated to clarify the difference between pension numbers reported in companies’ financial statements and the pensions’ funding health, as viewed by regulators. A company may be able to report improving pension plan health in its financial statements for shareholders so far in 2020 but have a declining measure of pension health on a solvency basis when reporting to regulators, owing to the use of different interest rates in their calculations.
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