Crisis or wake-up call? Experts debate state of pension industry

(May 26, 2003) The numbers aren’t good, but it’s probably too soon to declare a crisis in Canada’s defined benefit pension system. However, the industry does need to improve the ways it manages risk within pension plans. Those were the main conclusions from a one-day forum in Toronto last week, sponsored by the Association of Canadian Pension Management (ACPM).

The losses experienced by Canada’s defined benefit pension funds have been making headlines all year, prompting major questions about the health of the pension system.

According to numbers prepared by Watson Wyatt Worldwide, Towers Perrin and Mercer Human Resource Consulting, the average typical private sector pension plan in Canada is 78% funded. When the results are indexed to inflation, the ratio drops to 54%. Public sector plans fared better — with a funded ratio of 109%, dropping to 72% when indexed.

Steve Bonnar, a principal with Towers Perrin, pointed out that the plans in the study are underfunded to the tune of roughly $70 billion — with a total shortfall in the system of $225 billion. Bonnar said that’s equal to about 20% of the total gross domestic product of Canada.

Trying to pay that off, he noted, would mean an additional 2% of gross domestic product being deposited into pension plans over the next 15 years. “Unless we get a return to late 1990s capital markets,” he adds. But with poor equity market performance unseen since the 1930s, that’s not likely to happen.

With numbers like these, companies are going be looking very closely at their retirement benefits — and they might need to make some changes. Some companies will cover the shortfall, said Mercer’s Michel St-Germain. But the real problems are going to be companies that can’t. And that, he said, could lead to the termination of some pension plans in the future.

However, ACPM chair Keith Ambachtsheer said, “Is it a disaster? No. You can’t pay the fully-loaded benefit? Is that a crisis? Depends on your point of view.”

The numbers used to value pension liabilities came into question later in the day. And accountants and actuaries took some heat from industry members who believe the root of the current problems lie in the way risk is managed — or not managed.

Indeed, the pension system has had problems since its inception, according to Mercer’s Malcolm Hamilton. Equity markets aside, Hamilton believes that today’s difficulties are embedded in the system itself – and that it was bound to happen someday. Pointing to the short history of pensions in Canada, he said that “defined benefit plans aren’t old enough yet to be considered anything more than an experiment.”

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Hamilton said that actuarial assumptions and a lack of transparency in accounting rules for pension funds are problems that have been around since the beginning — and they are the real reason for many of the problems being faced today. As he pointed out, “The actuarial profession took a wrong turn” early on in the development of the Canadian pension system, leading to the use of “risky assets” such as stocks to build long-term safety.

Using smoothing techniques to obscure rather than manage risk has also contributed to the problem, Hamilton argued. The equity bull market of the 1980s and 90s merely masked issues that arose in the 1960s and 70s. But now old problems have come back to haunt the industry.

“We’ve managed risk in these plans by the seat of our pants,” Ambachtsheer admitted. “We need a sea change in getting rigorous about defining the risks in the system and managing them.”

Caroline Cakebread is a Toronto-based investment writer.

(05/26/03)