Funding at a crossroads

Held in conjunction with the Rotman School of Management’s Capital Markets Institute and CIBC Mellon, the event featured a panel of experts consisting of plan sponsors, money managers and a consultant.

With the Oct. 2 announcement that the federal government is considering easing the restrictions on pension plan surpluses, much of the conversation focused on reform and policy. Adam Bomers, director of investment research and solutions with Aurion Capital Management pointed out that Canada has been slow on this point compared to other countries.

“There are many Dutch plans that—before the storm—were 140% funded,” he said. “Even after what happened last year they’re still fully funded.”

A parallel issue is asymmetry regarding the ownership of a surplus. “Why as a corporation would I want to fund above 100% when I’m not sure if its mine? I think that’s the fundamental issue that needs to be dealt with in Canada.”

Regarding the options currently available to plan sponsors when it comes to limiting investment risk, the panel conceded there are few choices.

“There’s not a lot they can do,” said Bomers. “They can put more money into the plan, cut benefits, or change the asset allocation.” However, he noted a fourth option that some organizations have utilized; the timing of the filing.

“Plans are only required to file every three years, and there may have been plans that—for whatever reason—filed every year in the past,” he explained. “This year they might think, if I don’t have to file, why would I? I’d have to write a really big cheque. I think that’s another lever plan sponsors have used.”

LDI
The panel observed that the notion of liability-driven investing (LDI) was gaining steam—albeit belatedly—in the industry, but implementing an LDI policy is only useful in future downturns.

“It’s too late for LDI in terms of the current risk scenario,” said Leona Fields a pension fund manager with York University. “It doesn’t make sense to lock in an 80% funded status. You need to get up to fully funded status before you can have a meaningful LDI or a matching-type of strategy in place.”

Bomers agreed, and questioned why the strategy has seen such slow take up.

“I think it’s a great tool in the risk management toolbox for plan sponsors,” he said. “Is it the right time? I don’t know. However, it’s been put into action in the banking sector for the last 400 years, so I don’t know why it’s such a new thing for pension plans.”

An important point in the debate to remember is that Canada has three discount rates, said Soami Kohly, vice-president of LDI solutions with McLean Budden. “Plans here are forced to pick one specific type of valuation that they want to hedge and they’ll get some benefits from the other, and it’s hard for committees to actually make that decision,” he explained. “In the U.S. and U.K. there’s essentially one discount rate and for that reason, products that are used in those parts of the world are structured in portfolios quite easily.”

The Canadian market has another shortcoming in the lack of a synthetic bond market, noted Janet Rabovsky, a practice leader for central Canada, investment consulting with Watson Wyatt.

“Whether it be credit default swaps or interest rate swaps, it’s not as rich and broad as it is in the U.S. or U.K.,” she said. “For example, you could have someone who maintains 35% physical exposure to bonds, but uses derivatives to gain the rest of the exposure to get 80% to 90% interest rate risk management. It’s almost impossible to do in Canada.”

In terms of asset allocations, Kohly said he has seen many fixed income managers look to alternatives—specifically infrastructure bonds—as part of their portfolio. Fields explained that York University is moving along the same lines, with a current and expanding allocation to infrastructure and a possible move into real estate.

Reform
While most people in the industry would agree that pension reform is needed—and soon—the shape it should take differs depending on whom you ask.

“As is, the system isn’t working,” said Rabovsky. She explained that the proposed Alberta/B.C. supplementary pension plan looks promising, and that—absent a viable alternative from the federal government—Manitoba and Saskatchewan have indicated that they will join it, possibly sparking a move by more provinces to do the same. “I think what we need to do as a country is deal with the social policy aspects, not the least of which is the people who don’t have access to a reasonable pension.”

Fields explained that the industry trend of moving from defined benefit (DB) to defined contribution (DC) plans has given some plan sponsors an unrealistic view of their options in the event their pension plan became too cumbersome on their business.

“It seems to me that many employers thought they would switch from DB to DC when things got rough,” she said. “I think that there are a few court challenges waiting to happen. People are going to retire and look at their DC statement and say, this isn’t going to get me through my retirement years. Who can I blame?”

Bomers believes that the pensions debate is indicative of an economy in flux, and that individuals and organizations need to revisit their perceptions on saving habits and retirement.

“There’s been a shift in terms of the economics of running a pension plan in the last 20 years, but I don’t think there’s been a shift in terms of the mindset of what people expect to receive,” he said. “It’s becoming more and more expensive to run a pension plan, people are living longer, there’s a low interest rate environment, and from 1982 to 2008 there’s been a negative equity risk premium. Combine all those things together and the economics really don’t point to the survival of DB plans.”

Watch the 3-part video of the Funding at a Crossroads event Part 1, Part 2, and Part 3.

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