Dominion Bond Rating Services(DBRS)says the public perception of a serious problem in the funding of defined benefit(DB)pension plans in both Canada and the United States is a myth for over 90% of the plans it reviewed.

Its study, Pension Plans: The Myth of a Pension Problem, says there are a few myths and misconceptions relating to plan funding, such as:

• Companies have been neglectful and haven’t been contributing to plans;
• Firms have used aggressive assumptions to make plans appear to be in a better state than their actual financial position;
• By not reporting pension plan funding on the balance sheet, companies were hiding their real obligations; and
• Companies are obligated to fund post-retirement benefits

Of the 536 predominantly North American plans reviewed, the study finds that the unfunded liability collectively amounted to just US$55 billion(2.83%), based on overall plan assets of $1.8 trillion.

DBRS’s analysis focused on the effects of four areas: plan performance, assumptions used, demographics and legislative changes.

It says plans saw a marked improvement in their funded status over the past year and benefited from strong asset performance; increased contributions, partly due to more stringent regulatory rules; and changes to assumptions, specifically higher discount rates because of market expectations for long-term interest rate increases.

“Current assumptions for the vast majority of plans are at reasonable levels, and despite a trend to increase discount rates, current assumptions remain conservative,” states the DBRS study.

And since 2000, demographic factors have had a large impact on funding of plans. The trend is expected to continue and will pose new challenges for highly labour-intensive industries with strong unions, as baby boomers retire and a smaller pool of employees must support a larger number of retirees.

“However,” it says, “the shift to defined contribution plans, downsizing and a reduced demand for domestic labour has eased some of the pressure.”

Last year, there were two major regulatory changes in the United States regarding pensions. FAS 158, issued by the Financial Accounting Standards Board, reinforced disclosure requirements and required that pension and post-retirement benefit deficits be reflected on the balance sheet. The other regulatory change, the Pension Protection Act requires all DB plans to be fully funded in a seven-year period.

In 2006, the funded status of pension plans improved and more than 25% of the plans reviewed are now considered overfunded while 70% are deemed to be well funded.

DBRS believes the funded status is likely to improve further this year, leading to a larger number of fully funded plans. With a few exceptions, pension funding deficiencies are becoming less of an issue.

“These forecasts can be attributed to three key factors:(1)Expected increases in interest rates and therefore discount rates.(2)Reasonable equity returns.(3)Further employer adjustments to regulatory requirements,” it says. “Combined, these expectations should result in the elimination of pension deficiencies for North American companies over the next decade.”

To read the study in a PDF format on the DBRS website, click here.

To comment on this story, email craig.sebastiano@rci.rogers.com.