Pensions Still Not Out of the Woods

“The improvement is due to an increase in long-term interest rates that have lowered the cost of pensions,” says Paul Forestall, a retirement professional leader at Mercer.

He adds that funding ratios could have improved even more, but the index doesn’t account for contributions sponsors would have made over the past few years.

Meanwhile, Watson Wyatt found that pension funding ratios are at their highest levels in five years. For the average plan, the pension funded ratio — or the ratio of plan assets to plan liabilities — climbed to 102% by the end of Q2 2007. That’s up from 86% at the start of 2006.

Martine Sohier, a senior consultant at Watson Wyatt, also attributes the good news to increased bond yields over the past six months and healthy returns. “This is a good sign for sponsors in terms of funding requirements and on the accounting impact they may represent.” she says. “At this point, hopefully, deficiencies are a thing of the past.”

Mercer’s Paul Muldowney says strong equity markets were also a major contributor to pension plans’ good health.

But it’s not yet time to rejoice — plans’ positive fortunes could change in an instant. Ashley Crozier, an independent actuary, says an interest rate drop could force plans to become underfunded again, as equity markets slow. “There’s cause for subdued celebration,” he says. “Sure, it’s better than it was five years ago, but it’s still no euphoria.”

Sohier agrees. She says in June last year pension plans appeared to be funded, but bond yields dropped at the end of the year, affecting plans at their most vulnerable moment.

While she’s optimistic that bond yields won’t fluctuate during the year, she can’t be certain. “Liabilities are really affected by long-term bond yields,” she says. “This is something to continue to look at for the coming year. We hope things will stay at this level.”

That’s not the only reason for “subdued celebration,” as Crozier put it. Part of the pension plans’ current strength is a result of employers and, in some cases, employees topping off the plans for several years. “Employers are required to fund the deficit,” he says. “They’ve done all the heavy lifting.”

And plans’ being fully funded doesn’t mean employers will get a payment reprieve. A pension plan has to file a new valuation report in order to alter contributions, but that’s usually done every three years.

Crozier points out that increased operating costs might force plans to keep the status quo when it comes to payments. “Even if a plan files a valuation report, in most cases, costs are higher than they were five years ago, and that’s not good news.”

He says increased costs are a result of longer life expectancies. Also, promises of future investment returns are lower than they were five years ago. Consequently, the higher payments will need to continue. “Because of that, employers and some employees are still feeling the pain,” Crozier says.

As for retirees, Sohier says they can take comfort in knowing that their plans are fully funded. “Having a healthy pension plan means full security at that point. It ensures that the promise of benefits will be paid out.”

Crozier, on the other hand, says retirees won’t feel any effects, positive or negative, from a healthy pension plan. That’s because retirees in underfunded plans still receive full benefits. “There’s no reason for them to breathe a sigh of relief, since they didn’t have to hold their breath before.”

But plan sponsors can’t just sit back and relax because plans are fully funded. Sohier says now is a good time for them to reevaluate investment strategies. “The focus should be on long-term strategies to eliminate volatility,” she says. “It’s important to focus on design and investment structure to alleviate that risk.”

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