Pension plan ratios improved in 2007: Watson Wyatt

While last year’s market turmoil wreaked havoc on much of the investment industry, one area that not only survived but improved was pension plan–funding ratios.

According to a new Watson Wyatt report, the typical pension plan enjoyed 106% funding at the end of December — a 10% increase over the same time in 2006.

David Burke, retirement practice director in Watson Wyatt’s Canadian office, says this is the highest funded ratio since April 2002. He says that while this is reason to celebrate, plan administrators should not rest on their laurels. “While this is good news, this is no time for complacency,” he says. “Significant cost volatility remains a key influence behind many of the decisions made by pension plan sponsors.”

The numbers are somewhat surprising considering the trouble the equity markets faced in the last half of 2007 and the rise of the Canadian dollar. But Burke points to increased yields on high quality corporate bonds as the saving grace for pensions.

“This illustrates the hazards of basing pension plan liability assessments, measured on a GAAP basis, on point-in-time, mark-to-market pricing of bonds,” he says.

Watson Wyatt adds that the rising yields occurred due to the problems with asset-backed commercial paper and contrasted the falling yields on Government of Canada bonds.

It also helped that 2007 wasn’t a particularly volatile year for pension plans, which might be shocking to some, considering how uneven the rest of the market was. “Despite the impression that 2007 was a highly volatile year for equity markets, it was in fact one of the lower volatility years for pension assets since 1993 based on month-over-month changes,” says the company.

Burke adds that it’s “fair to assume that volatility in funded ratios could even be higher in 2008 and future years than it was in 2007.”

The benefit of having fully funded ratios is that a normal plan can now have a cushion against future market issues. In fact, Carl Hess, director of Watson Wyatt’s investment consulting in North America, says sponsors might want to consider lowering the volatility of funded status and costs “in an environment that may punish uncertainty.”

Besides revealing the plans’ high ratios, the Watson Wyatt report explains that in 2007, aggressively invested funds had returns “well below” long-term expectations. Funds with high allocations in U.S. equities fared poorly, while funds with currency hedging did well.

The company adds that “more conservatively invested mixed funds and bond funds have had higher positive returns, but are still below long-term expectations.”

So what do higher ratios mean? “For corporations, it means that their pension balance sheet will look a little better this year,” says Doug Chandler, senior consulting actuary for Watson Wyatt.

Despite the bright year, the pension industry isn’t fully recovered from the turmoil it experienced a few years ago. “It’s not the case that the trouble we saw in 2001 and 2002 has gone away,” says Chandler. “This might be some temporary relief, but the issue is still there.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com