Deep Impact

It’s clear that the events of 2008 have had a tremendous impact on pension investments and the organizations overseeing these benefits. The losses were significant. According to a 2009 SEI Investments survey of 157 executives in Canada, the U.S., the U.K., the Netherlands and Hong Kong, the majority (76%) reported a loss of at least 11% on a total portfolio basis in 2008. Forty-six percent of executives reported a loss of 21% to 30%, while 10% reported a 31% to 40% loss.

Changing Times
These losses have translated into funding deficiencies and the burden of increasing pension contributions. When asked about the impact that cash contributions to the plans would have on their businesses (despite available relief or the prospect of it), half of the executives stated that their companies could make the required contributions, but not without a significant impact on overall corporate finances. Eleven percent admitted that their organizations would not have the cash to make the required contributions.

In response to the market volatility, many organizations made changes to their asset allocation policy. In 2008, 64% of participants made changes (38% did so in the last half of the year). Of those who made asset allocation changes, Canadians acted less aggressively in shifting assets away from equity markets and into bonds—36% in Canada have done so, compared with 43% in the U.S. Thirty-two percent of U.S. organizations diversified out of equities into alternatives versus 28% of Canadian organizations. Perhaps this indicates the start of an alternative investment trend, which has been slow in establishing itself in Canada to date in small and medium-size pension plans.

Solvency Solutions
In Canada, pension executives are somewhat concerned about their ability to obtain member consent to extend solvency payments. They are split on whether or not they’ll be able to secure it, with 54% expecting plan members to provide consent.

Interestingly, organizations in jurisdictions that currently permit the use of letters of credit for funding purposes have not been active in using this option. According to the SEI survey, only 22% are taking advantage of it. Although new jurisdictions will be allowed to use letters of credit, it does not seem likely that a huge issuance of such instruments will be appearing in pension trust accounts, due to the combined hurdles of obtaining member consent and obtaining letters of credit at attractive fees—or, for some companies, obtaining them at all.

The Brighter Side
While it remains uncertain, the future for defined benefit (DB) pension plans does seem more positive in Canada than south of the border. Half of Canadian plan sponsors experienced drops in funding levels in the 11% to 20% range. However, no Canadian plan sponsors reported a funding level decrease of more than 30%, compared with 13% of U.S. sponsors.

Further evidence of a rosier DB future in Canada is the fact that Canadian plan sponsors are less inclined to make adverse plan design changes in response to the recent market turmoil. Only 20% of the Canadian executives surveyed (versus 46% in the U.S.) feel the volatility has increased their likelihood of terminating their pension plans in the near future. And Canadians appear to be more committed to offering DB plans. Survey results show that in Canada, 70% of plans are active and open to new entrants (versus 55% in the U.S.), 27% are closed to new entrants (versus 34%), and only 3% are closed to new entrants with accruals frozen (versus 10% in the U.S.).

In this new economic reality, organizations need to revisit how their plans fit into their near-and long-term benefits structure. Plan sponsors should be proactively analyzing all options, taking into consideration plan affordability as well as the effectiveness of their monitoring and management processes. While managing pension assets in difficult capital markets is not an enjoyable task, it is crucial that plan sponsors don’t avoid making critical business decisions.

David Lester is a CFA with SEI’s global institutional group.
dlester@seic.com

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© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the July 2009 edition of BENEFITS CANADA magazine.