Pension crisis looming?

(April 5, 2005) Keep an eye on the pension universe in the next couple of years. Changes to the way companies administer their pension plans mean clients will probably be making more investment decisions related to those plans and funding formula changes are probably going to affect what they get at the end of the day.

The number of chief financial officers who say Canada is facing a pension crisis more than doubled this year. In fact, according a survey by Watson Wyatt Worldwide and the Conference Board of Canada, 43% of CFOs polled for the 2005 Survey on Pension Risk, say problems in the pension system are widespread and will persist in the coming years. Only 20% felt this way in 2004.

The top threats CFOs identified to private sector defined benefit pension plans included the aging workforce and resulting volatility of future funding contributions and the effect volatile pension expenses will have on future company financial statements.

The Supreme Court of Canada’s decision in Monsanto v. Superintendent of Financial Services is also throwing a wrench in the works. The court decided that any pension surpluses a company may have accumulated must be paid out to terminated employees if the company sells part of the company or wraps up the plan in some other way. The decision may cause plan sponsors to take steps to avoid ever creating a surplus or rainy day cushion, thereby avoiding the requirement to distribute it. This additional risk may cause plan sponsors to consider moving away from DB plans in the future.

To manage, nearly half of the CFOs surveyed say they are taking steps to address the crisis. At least a few of these factors could bring questions and calls for advice to your door.

Approximately 47% of respondents said they had already taken steps like reducing the normal retirement benefit accrual rate, early retirement benefits or indexing formulas. Nearly one quarter (24%) of respondents say they are reducing other benefits or increasing the required employee contributions (28%) and some say they are looking at converting to a defined contribution (DC) structure or planned to do so within the year.

In a DB plan, the employee’s pension is determined by a formula that usually accounts for employee earnings and years of service. The plan provides a guaranteed level of benefits on retirement and the onus is on the employer to make good on that promise. In DC plans, the amount clients receive on retirement is a result of employer and employee contributions to the plan plus any investment gains or losses. Employer contributions are fixed, usually expressed as a percentage of the plan member’s salary, and pension assets are not guaranteed.

CFOs are still assessing critical issues regarding company pension plans and the implications for their organizations, but financial factors, especially volatility, are driving change more than human resource concerns, says Ian Markham, senior consulting actuary, Watson Wyatt Canada. One of the major threats to DB plans is changing employer views — only 50% say a pension plan is good tool for attracting and retaining employees.

For now, the majority of those surveyed say they are contributing the minimum needed to keep plans funded but solutions are all over the map and they include a lot of plan design changes. A summary report of the survey is due out this summer and the full report is expected in the fall.

Filed by Kate McCaffery Advisor.ca, kate.mccaffery@advisor.rogers.com