Pension plans get a clean bill of health

Pension plans can cancel that next visit to the doctor — turns out they’re at their healthiest in years. A report released by Toronto-based rating agency DBRS says that despite what the public might think, pension plans are well funded and will continue to be for some time.

According to the report, more than 90% of the 536 defined benefit pension plans reviewed can be considered well funded. The underfunded liability came to $55 billion — chump change compared to overall plan assets of $1.8 trillion.

One reason for the healthy verdict? Plan performance improved. The report says that “strong asset performance with a booming global equity market” contributed to the positive outlook, while increased contributions and changes to assumptions also helped pension plan funding.

This is good news for plans and for the public. In 2003, plans were in disarray as the tech bubble burst and stock markets plummeted. Making matters worse were falling interest rates.

But these days a strong stock market, higher employer contributions, stricter regulatory requirements and more conservative assumptions have brought pension plans back to health.

DBRS is optimistic that plans will remain fully funded in the future. “We said it last year — it’s all about assumptions,” says Mary Keogh, managing director, policy and regulatory affairs, at DBRS. “It’s the same theme but better. The power of high interest rates favours the odds of improvement.”

Steve Bonnar, a principal at Towers Perrin, agrees that pension plans are healthy but says he’s not quite as optimistic as DBRS. He argues that interest rates won’t rise and that in the long-term they’re likely to drop. “Since the beginning of the year, interest rates have risen about 50 basis points,” he says. “I’m not sure how much farther they’ll continue to rise.”

Future health also depends on employer contributions, which, DBRS says, will continue. “Companies have maintained strong balance sheets … which will allow for greater contributions,” says the report.

But Bonnar says plans that are fully funded will see their contributions drop, as employers reduce their payments to the bare minimum. “You only have to pay the deficit once,” he says. “Plans are not going to continue to have really high levels of cash contributions, even though they may be able to afford to pay it.”

While Keogh admits plan sponsors will have some leeway when it comes to payments, she doubts they’ll reduce their contributions significantly. “That would be unwise,” she says, adding that in the States, plans are forced to become fully funded within a seven-year period.

DBRS cites other reasons to remain optimistic, including growing emerging markets, which will “lead to an overall increase in global trade and good investment opportunities”; new regulations in the U.S., including FAS 158 and the new Pension Protection Act of 2006; and the size of a company’s obligation being reduced as fewer employees are added to the defined benefit plans because of outsourcing and reduced domestic labour requirements.

Bonnar has trouble with the last point, saying that he thinks the relative size of a company’s pension obligation will rise, not fall. “Reduced domestic labour requirements will end up with increasing pension liability and a reduction in payroll.”

He cites an example of a company that sells off a division but is still obligated to previous retirees. “They may have gotten rid of the liability for people actively employed, but they retain some obligation. Now you have a larger obligation relative to the size of the company.”

While Keogh stands by the company’s positive assessment, she says things can go wrong that would change DBRS’s future outlook. “The impact of a perfect storm — a weak market and reversal to a lower interest rate — would alter our forecast,” she says.

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