Improved market conditions and regulatory changes are improving the funding positions of Canada’s pension plans, but challenges in funding will remain into the foreseeable future, according to the DBRS 2011 Pension Study.
The study is based on the results for 479 DB plans, over the span of 2002 to 2010.
Superficially, pensions appear to be “significantly underfunded,” says Kent Wideman, chief credit officer at DBRS Limited. In fact, at first blush, they appear to be in the same bad shape as they were in 2002.
“However, the health of pension plans is actually stronger today than it was following the 2001 dot-com crash,” he says. “This strength is attributable to significant employer contributions over the last decade, driven largely by regulatory reform.”
These top-up contributions have replenished plan assets and, to some extent, counterbalanced the volatility of capital markets over the years included in the study. What appear to be large funding gaps are “almost entirely” due to multi-generational low discount rates employed by actuaries in determining plan obligations. These calculations may overstate a plan’s obligations, creating the illusion of a large funding gap—in essence, modeling a worst-case scenario.
“Nevertheless, defined-benefit plans continue to face fundamental challenges,” says Wideman. “Although DBRS continues to view the pension situation as manageable for most companies, this does not negate the reality that a sizable defined benefit pension plan represents a very long-term obligation for a company, with inherent risks and uncertainties that could lead to funding pressures at inopportune times.”
In Canada, regulatory changes over the past decade may be beneficial in some circumstances, but Wideman warns that DB sponsors must remain vigilant in maintaining manageable pension positions.
One of the challenges that DB plans present to sponsors is Bill C-501, tabled in Parliament in March 2010. This bill would amend the Bankruptcy and Insolvency Act to grant secured status to unfunded pension plan liabilities in bankruptcy proceedings. This change would place the plan ahead of bondholders in the capital structure
As a private member’s bill, C-501 didn’t go anywhere, but it did spark a discussion on the rights of DB plan members, creating uncertainty for the industry and sponsors. If similar legislation were to pass, sponsors of severely underfunded plans could see their debt downgraded, raising the cost of capital.